No. of Recommendations: 1
In the context of long calls, the advantage is that the lower the leverage (deeper in the money the strike is), the lower the implied interest rate on the borrow is
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Roughly, but not exactly and not always.
Example, XSP on 7/17/24, expiration 6/18/26. XSP at 561.85
Assuming price 3/4 into the spread...
True enough.
But the little outliers are usually the result of someone actually being in the middle of trying to trade one of those contracts. Thus the bid and ask you see at that level aren't the (mostly) smooth curve you generally see from market makers, but somebody's actual bid trying to execute in the middle of that range. Sometimes this is clear from looking at the bid size across the strikes. You might see 50,50,50,3,50,50.
If there is a big outlier I sometimes patch the bid in my spreadsheet to be the average of the next higher and next lower numbers, just so my little graph looks pretty. That's because your probable execution price is a percentage across the market maker's bid and ask, not usually the bid or ask of an actual counterparty.
Separately, it's true that the implied interest rate is often about the same for deep in the money strikes and DEEP in the money strikes, and so the statistical noise dominates, leading you to see slightly higher and lower rates around a pretty flat central trend. The implied rate improvement is mainly seen closer to the stock price.
Jim
