Is it plausible for the bid / ask spread to move upward with zero volume and an option expiring worthless on the same day?

Question

I'm studying historical options quote data, experimenting with different trading strategies and here's an example of what information I have for every option, recorded hourly:

| [ 02-20-2004 16:00 ] UNH 2/21 40c on 02-20-2004 {
  open: 0,
  high: 0,
  low: 0,
  close: 0,
  bid: 21,
  ask: 21.1,
  underlying: 'UNH',
  strike: 40,
  last_volume: 0,
  bidsize: 50,
  bid_date: '2004-02-20 16:00:00',
  asksize: 30,
  expiration_date: '2004-02-21',
  option_type: 'call',
  symbol_alt: 'UNH_2004-02-21_40_call'
}

To simulate the trader's disadvantage when buying / selling options I planned on calculating the cost (what we can buy it for) and value (what we can sell it for) as:

spread_size = ask - bid
spread_middle = (bid + ask) / 2
disadvantage = 0.15
cost = spread_middle + (disadvantage * spread_size)
value = spread_middle - (disadvantage * spread_size)

but what I did not expect was for the bid / ask to be nonsensical with zero volume OTM expiring options. Now I'm trying to understand if the data I have is flawed, or my understanding of how to estimate option value is flawed. Is it not true that as an option is nearing a worthless expiry, the bid / ask should reflect that?

Look at the data above. According to the data, on 2/20/2004 at 16:00 (end of day on Friday, so the moment of expiry for this option) UNH 2/21 40c had a bid / ask spread of 21 / 21.1 with a bid size of 50 and an ask size of 30 (amount the market maker is willing to buy / sell), and 0 volume. The strike is 40 and UNH on that date was worth between 30 and 31 Should the bid / ask not be close to 0?

Can someone explain whether this is a plausible phenomenon, and if so, how I can use the information available to determine realistic cost and value estimates rather than using the formula above?

Or whether, rather the data seems wrong and I should contact my data supplier, who I paid 4 figures?

Answer 1

Yes, a call that is 10 points out-of-the-money and about to expire should be worthless. So the obvious conclusion is that you are looking at bad data.

Is there a plausible explanation for this scenario that does not involve the call being worthless or looking at bad data? Perhaps, but I can't make sense of it. From Googling, I found two items:

1. 10/27/03: MAMSI, which recently replaced Blue Cross and Blue Shield of North Carolina as a health insurance provider at WakeMed, has agreed to be acquired by the nation's largest health insurer, UnitedHealth Group, in one of two multibillion-dollar health insurance mergers announced Monday. UnitedHealth will pay roughly $2.95 billion in cash and stock for Mid Atlantic Medical Services Inc., whose shareholders will get $18 a share in cash and 0.82 shares of UnitedHealth for each share of MAMSI they own.

2. The closing price of UNH common stock on the date of the merger, February 10, 2004, was $60.00. Pursuant to the merger, Joe received: • 82 shares of UNH common stock worth $4,920 on February 10, 2004; • $1,800 dollars in cash merger consideration. On the date of the merger, the total value of all consideration received by Joe was $6,720.

Note that the date of your option quote was 10 days after this merger. Existing options for MAMSI would have been adjusted for the terms of the merger. Let's say that the option root symbol was MAM. The root symbol for the adjusted options would then become MAM1. If this isn't bad provider data then my guess is that your data provider might be showing you adjusted MAM1 options under the takeover symbol of UNH.

Ughh, adjusted options give me a headache. I did not find an adjustment bulletin at either the OIC or OCC so without those details, I'm just guessing here.

Contact your data provider and see if they can clarify this.