Futures underlying for index options

[grantx]

Some index options – DAX, Stoxx, FTSE – which do not trade on the quarterly cycle have expiration dates which do not correspond to an underlying future/future expiration date.

Quarterly options and futures are December options/December future, March options/March future, June options/June futures.

But what is the underlying for the remainder, eg January and February options? I’ve been calculating a future fair value for the underlying with the expiration date equal to the option expiration date. Now I’m having doubts as to whether this is correct.

Advice greatly appreciated.

Grant.

 

[fiftyfifty]

The underlying for any of these options is the cash market, not the future unless these options settle to futures. Just look at the exchange website to see what the settlement method is. Also on the website it will give a calendar for expirations etc.

Generally equity futures on a quarterly cycle expire on the third Friday.

Hope this helps you a bit.

 

[grantx]

Fiftyfifty,

The underlying for these options is the future value of the cash market, ie the fair value determined by the cost-of-carry.

I need to know whether I use the next expiring quarterly future, eg March future for Jan option, or determine an intermediate Jan future fair value.

Grant.

 

[fiftyfifty]

If you can calculate the cash fair value for the expiration date and take the different basis (of future) into account if hedging with futures then this would appear to be fine. Note that when the options expire you will have a naked long/short futures position if you don't deal with this position before the expiration or trade out of beforehand.

Only limited options knowledge so hopefully not putting you in the wrong direction.

An index like the Cac has monthly futures, you could try pricing monthly options against the quarterlys and see if you calculations run into trouble.

 

[grantx]

Fiftyfifty,

Thank you for your suggestions, and I'm touched by your concern re position exposure. Don't worry - I only need verification for the purpose of calculating (correct) implied volatilities.

Re your CAC suggestion, I did this and the results were way out suggesting that my original approach is (may be) correct. However, I will need to verify this to my own satisfaction. It occured to me that confirmation could come via possible arbitrage violations using conversions/reversals/synthetics. We'll see.

Why isn't life simple? Why doesn't God like me?

Thanks again.

Grant.