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On Jul 28 2020, u/OGdungeonmaster asked:

I have 10 $7.50c options for Euronav [[EURN:NYSE](https://finance.yahoo.com/quote/EURN?p=EURN&.tsrc=fin-srch)] that expire 11/20. They show they are worth $2.18 each yet the stock is at $9.72. Why would they be worth less than the strike price plus the option premium? This bc it is so low volume or because it is indicative that its going to go down?

u/NBKkevlar answered, with 11 upvotes to date

Probs cause of the low volume, looks like only 1 contract was traded today for that exp/strike. The bid/ask as of market close was 1.95/2.40. So technically people are only selling those contracts for 2.40. which means the contracts are trading slightly higher than strike price plus the option premium.

I’m pretty sure the 2.18 that they’re “worth” is what you would most likely get if you sold them using a market order

I don't understand why volume remains low, or how low volume answers the question. Why wouldn't an arbitrageur or market-maker swiftly enter, and buy the undervalued call?

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Selling a heavily in-the-money call is effectively a financing transaction - the large option premium is a large cash inflow for the seller, and the risk is very similar to a straight long/short position in the underlying. Market makers do not want to extend financing to other entities via option premia, and so in-the-money options typically trade cheap.

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When you are dealing with such comparisons, the first thing to do is to verify that the quotes are from real time because with illiquid options, the option quote is often stale.

Let's assume that the quotes are good. At \$9.72, the intrinsic value of the \$7.50 call is $2.22. The broker is showing that "they are worth 2.18 each" because they are simply averaging the bid and ask prices. That's not an accurate reflection of actual worth. If the bid/ask briefly changed to \$2.00 by \$3.00 with no change in underlying price, would the average of \$2.50 then be what they are worth? Hardly.

The reality is that ITM illiquid options have wide spreads and the bid usually trades below parity. You could place a STC order for a higher price. Maybe another trader comes along and you get 5, 10, 15 cents of price improvement but there is no incentive for the market maker or anyone else to give you the full intrinsic value. While waiting for a better fill, XYZ could drop in price and you would give back some of your long call's gain.

So yes, if you sell at the discounted bid, you'll take the haircut and the market maker or floor trader who buys at that price will exercise for the arb.

If you don't want to take the haircut and you have the funds in your account, do this Discount Arbitrage yourself, avoiding the haircut. Short the stock to lock in the intrinsic value and then exercise the call. If instead you exercise first, you'll have brief market risk and maybe you do better, maybe you do worse.

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