A number of methods for estimating a limit price for execution.
|The price implied by the at-the-money option. Buying stock is equivalent to buying a put option to sell that stock once the order has fully filled 1. The premium of the option sets the limit price. This option valuation is an approximation for short term options and ignores the risk free interest rate 2.|
|The price implied from the impact of trading % of the expected market volume. This uses the common 'square root' estimate for market impact, the impact being proportional to the participation rate 3.|
- My continued thanks to Amaury De Ternay, then at BNP Paribas Asset Management, for making this observation in 2004.
- More on this at www.espenhaug.com
- The 'square root' estimate was introduced by Barra in 1997 and has been regarded by many as a robust estimate since then. The topic is still being debated: read more recent studies on arxiv.org at 1412.0141, 1412.0217 and 1412.2152.