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I am backtesting an algorithm with a 60-day warmup that is seeing bizarre theta values.
For example with SQQQ, on 2023-02-01 at 15:15, the algorithm sorted for lowest theta (highest magnitude of theta) of put options and found SQQQ 220204P00064000 while the underlying was trading at $37.11. Greeks.Theta was listed at -691.83, an absurdly high decay rate. If my math is right, the intrinsic value was $26.89 but it filled for even less at $26.80.
Clearly that -691.83 value is not the average daily decay rate of the extrinsic value. What is that number? Is the actual theta recorded in the option chain?
Many thanks, Marty
Louis Szeto
Hi Marty
We've tried and cannot reproduce this issue. The delta values of deep ITM puts around that time were looking normal to me (please run the attached backtest). Can you attach a backtest/code snippets for us to provide further assistance?
Best
Louis
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Marty Scholes
Thanks for following up. The following code produces some weird theta values, or I could be reading it incorrectly. I appreciate any insight.
Louis Szeto
Hi Marty
For 0-DTE options, it is expected that their absolute theta values must be greater than their intrinsic values, since their price have to go to zero in less than a day.
Yet, I agree that -800 is a bit too extreme for a $36.5 0-DTE underlying. It is a common issue for finite differencing option model like Crank Nicolson. The more steep the first derivative is, the higher the estimation error. Instead, using Binomial Cox Ross Rubinstein model would yield a -40 theta, which is reasonable.
Best
Louis
The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by QuantConnect. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. QuantConnect makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances. All investments involve risk, including loss of principal. You should consult with an investment professional before making any investment decisions.
Marty Scholes
Loius,
Thank you for the feedback. I may be misunderstanding what I am seeing. From the logs in the attached backtest, I am seeing the following:
From the above, I am calculate:
This implies that a far ITM put with a strike double the underlying price with negative extrinsic value expects the extrinsic value to decrease an additional $861 each day.
Does that make sense?
Thanks again.
Louis Szeto
Hi Marty
Your calculation process is not wrong, and it makes sense as the probability of the option being ITM is much lower by 1-day closer to expiration, so the option is basically worthless. But as I've mentioned, “-861” is not a reliable figure, as it is coming off an inaccurate model. Instead, try to use Binomial models as suggested by many scholars might yield a better result for American options.
Best
Louis
The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by QuantConnect. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. QuantConnect makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances. All investments involve risk, including loss of principal. You should consult with an investment professional before making any investment decisions.
Marty Scholes
The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by QuantConnect. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. QuantConnect makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances. All investments involve risk, including loss of principal. You should consult with an investment professional before making any investment decisions.
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