Fair Value Pricing

Learn how we calculate fair value and construct the bid-ask spread for various position types.

The mark price of a position is just that: the price where the position's value is marked at a given point in time. In other words, in the case of a multi-legged options position, it is the aggregate value of the entire position and is, therefore, subject to interpretation.

On a typical broker platform, the mark price of a position is usually synonymous with the mid-price. Creating a new order dialog, be it opening or closing, will default to the mid-price of the combined legs, assuming it's a multi-legged order.

But for bots, the mark price of a position is more complicated than just the mid-price.

In order to prevent erroneous triggers in bot automations we must ensure, or at least significantly minimize, the occurrence of false positives.

Assume a bot's monitor automation sends a closing order to the broker if the position return percentage is greater than 50%. The trigger here is the value of the return percentage, which is determined by comparing the mark price to the initial premium.

If bots used the broker-defined mark (i.e., mid price), the closing order would be sent as soon as the mid-price approached the 50% return value. But prices are not static, and they don't move linearly. Instead, price moves above, below, and around 50%.

To combat this, bots use the Option Alpha Mark, or what we like to call the pessimistic mid.

The pessimistic mid price, in short, is a calculation for purposefully under- or over-valuing a position or opportunity to more accurately dictate bot actions and avoid false-positive decision outcomes.

The primary components of each calculation are the mark25 and mark75  which represents the bid price + 25% of the spread width and the bid price + 75% of the spread width, respectively.

The goal of each mark calculation is to value each leg of a position or opportunity approximately 75% of the way across the bid/ask spread in the direction not in favor of the leg type (i.e., long or short). The mark price is then the aggregate price of the combined legs. The wider the spread on illiquid securities, the more apparent the divergence between the "naive mid" and our mark.

The following sections describe how each position type is marked, where markPrice is the calculation used to value an Opportunity and markClose is the calculation used in decision logic prior to closing an already opened position.

Equity

Single Option

Spreads (2 legs)

Credit

Debit

Spreads (4 legs)

Iron Condor / Butterfly

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Example

The formula for a debit spread mark is the long leg's mark75 price minus the short leg's mark25 price, i.e., you're always 75% of the way across the spread in the direction not in favor of the leg.

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