I would have to look into it but when ever I think I've found free instrinsic value it's because I'm looking at the price of the cash instrument not the future the option will expire against.
In the case of the US indexes non quarterly options expire against the next quarterly future.
I got caught out late last year on a dow trade where I had hedged Oct Dow calls against Oct Dow futures but on settlement day the future was settled against the cash index and the options were settled against the Dec Dow futures. ie I thought I had a profit in the bank but when they settled against a different future to the one I was expected I lost £5,500!
I'd appreciate if someone with more experience with me would confirm this though.
Maybe you're Feb call shows a profit against the cash or Feb future but against the March future that it will se settled against at the end of Feb it will be showing a loss.
Like I said would love an experience options trader to qualify my thinking.
Stephen McCreedy
In the case of the US indexes non quarterly options expire against the next quarterly future.
I got caught out late last year on a dow trade where I had hedged Oct Dow calls against Oct Dow futures but on settlement day the future was settled against the cash index and the options were settled against the Dec Dow futures. ie I thought I had a profit in the bank but when they settled against a different future to the one I was expected I lost £5,500!
I'd appreciate if someone with more experience with me would confirm this though.
Maybe you're Feb call shows a profit against the cash or Feb future but against the March future that it will se settled against at the end of Feb it will be showing a loss.
Like I said would love an experience options trader to qualify my thinking.
Stephen McCreedy
Stephen,
That’s frightening. I had to read this few times but I think I may know why (guessing). The FTSE or DAX, for example, are cash settled, ie at expiry profit/loss is determined by the amount an option is itm or otm in relation to the Cash market. There is no formal exercise.
I suspect the opposite is the case with DOW options – at expiry, if profitable a long or short future position will result. But this doesn’t explain why Oct Dow calls can’t be exercised against Oct futures. I think I’m still puzzled.
However, why did you hedge and hold to expiry? Wouldn’t it have been better to close the position at the time of placing the hedge and taking the profit? After all, by hedging you are protecting your downside but sacrificing your upside, hence no (or limited) further gain. Please correct me if I’m wrong.
Grant.
That’s frightening. I had to read this few times but I think I may know why (guessing). The FTSE or DAX, for example, are cash settled, ie at expiry profit/loss is determined by the amount an option is itm or otm in relation to the Cash market. There is no formal exercise.
I suspect the opposite is the case with DOW options – at expiry, if profitable a long or short future position will result. But this doesn’t explain why Oct Dow calls can’t be exercised against Oct futures. I think I’m still puzzled.
However, why did you hedge and hold to expiry? Wouldn’t it have been better to close the position at the time of placing the hedge and taking the profit? After all, by hedging you are protecting your downside but sacrificing your upside, hence no (or limited) further gain. Please correct me if I’m wrong.
Grant.
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It is possible for European style options to trade at less than intrinsic value. You need to look at the forward value of the S&P rather than what the S&P is "trading at", i.e, the cash and then it will make sense.zeno22 said:
Forward = cash market + risk free rate - dividends
So where there are heavy dividends expected the forward could be substantially less than the cash. Where futures are available in the month of option expiry, use that value as the forward. If not, then you need to work the numbers yourself.
Hope that helps, if not, just shout.
Zeno22
Before distractions of cash vs futures and dividends etc drags it into too much confusion.
The maximum value of a vertical spread at expiry is the difference between the strikes. In your example of 1350/1400 spread at expiry it will be worth 50 points if S&P is anywhere above 1400 at expiry. It will be worth zero if the S&P is anywhere below 1350.
At 1450 it has "intrinsic value" of 50 in a way (as it does if S&P is at 1,000,000) but the only place it can go in expiry value terms is down so it is never going to be priced anywhere other than between zero and 50 no matter how high the S&P gets.
Before distractions of cash vs futures and dividends etc drags it into too much confusion.
The maximum value of a vertical spread at expiry is the difference between the strikes. In your example of 1350/1400 spread at expiry it will be worth 50 points if S&P is anywhere above 1400 at expiry. It will be worth zero if the S&P is anywhere below 1350.
At 1450 it has "intrinsic value" of 50 in a way (as it does if S&P is at 1,000,000) but the only place it can go in expiry value terms is down so it is never going to be priced anywhere other than between zero and 50 no matter how high the S&P gets.
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