how to price pre-IPO stock option

quantcook · October 23rd, 2015, 2:10 am

if a tech company is going IPO next month, is there a model to value their call or put options now?if the industry profile and company past balance sheet and revenue are known, what is the best practice to value and hedge this option.

spursfan · October 23rd, 2015, 7:16 am

All you need is a comparable vol estimate - balance sheet and revenue won't help much

quantcook · October 23rd, 2015, 1:06 pm

spursfan, comparable means similar company in same sector?QuoteOriginally posted by: quantcookif a tech company is going IPO next month, is there a model to value their call or put options now?if the industry profile and company past balance sheet and revenue are known, what is the best practice to value and hedge this option.

Traden4Alpha · October 23rd, 2015, 1:48 pm

I'd think that the best model would be a composition of: 1) a sampling of the vols of comparable companies (nearest neighbors in the sector space & relative position in the growth-maturity curve); 2) a characteristic vol-of-vol or envelop-of-vol model for how the vol of IPO issues evolves from the first day of trading.

Alan · October 23rd, 2015, 2:42 pm

Besides the modeling issues already mentioned, once trading starts, the stock will typically be "hard-to-borrow".This will introduce significant complications/distortions in the options. Roughly, the borrowing cost acts like a stochastic implicit dividend. Perhaps to do it right, you need good access to real-time and historical borrowing costs and a good feel (or model) for how this will play out for the issue in question. This should affect any pre-IPO option valuation attempt, IMO.