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.