Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A)
No. of Recommendations: 2
OT: Options
I just noticed something about SPX options versus SPY options that at first surprised me, although then I rationalized it.
Maybe an expert could offer their opinion, in case I'm totally off-base?
The thing that suprised me is that for SPY options the ask is always greater than IV (intrinsic value), and understandably so because otherwise there'd be an arbitrage opportunity (see below).
But for SPX options, ask is not always greater than IV (it can be, but doesn't have to be).
I *think* the point is that you can't hold, i.e. buy or sell SPX 'shares', whereas you can hold SPY shares.
So that arbitrage argument doesn't hold for SPX. But arbitrage is what makes prices sane, I get a little uncomfortable when it doesn't hold.
Maybe the whackiness demonstrated below just doesn't matter. Maybe I'm having a brain freeze. So wanted to ask for a double check of my thinking.
Below are some snippets of a SPY options chain with IV, and then a SPX options chain with IV:
7/27/2024: SPY 544.22
expiry April 17 2025 ITM SPY puts:
strike 570 bid 33.03 ask 34.24 IV 570-544.22 = 25.78: bid and ask greater than IV
strike 580 bid 38.99 ask 40.54 IV 580-544.22 = 35.78: bid and ask greater than IV
strike 590 bid 46.17 ask 47.94 IV 590-544.22 = 45.78: bid and ask greater than IV
strike 600 bid 54.69 ask 56.72 IV 600-544.22 = 55.78: ask greater than IV
strike 610 bid 64.41 ask 66.66 IV 610-544.22 = 65.78: ask greater than IV
strike 650 bid 104.30 ask 106.79 IV 610-544.22 = 105.78: ask greater than IV
CONCLUSION:
SPY ask is always greater than IV.
This makes sense because otherwise there'd be "free money", i.e. if you held SPY shares and if the ask were less than the IV then you could buy that put and pocket the difference i.e. an arbitrage opportunity.
Now look at SPX:
7/27/2024 SPX 5459
expiry April 17 2025 ITM PUTS:
strike 5700 295.50 298.10 IV 5700-5459 = 241: bid and ask greater than IV
strike 5800 342 345.30 IV 5800-5459 = 341: bid and ask greater than IV
strike 5900 386.70 410.70 IV 5900-5459 = 441: bid and ask NOT greater than IV
strike 6000 447.80 471.80 IV 6000-5459 = 541: bid and ask NOT greater than IV
CONCLUSION:
SPX ask is not always greater than IV: it is for nearer ATM strikes but is not for more ITM put strikes
You can't hold, i.e. buy or sell SPX shares, so the arbitrage argument for SPY doesn't hold for SPX.
But arbitrage is what generally keeps market prices sane.
So I was a little surprised to see the lack of arbitrage to keep a SPX 'ask' in a sane relation to IV.
It just doesn't matter if it's not sane (given no "shares" to buy or sell)?
I was also suprised that the SPX bid/ask didn't have a more uniform relation to SPY bid/ask.
No. of Recommendations: 2
No offence, but I suspect a data or calculation error. Maybe obvious, maybe subtle, possibly both : )
First thing to check: When you calculated this, was this a snapshot of bid/ask and index level and SPY price at the exactly the same moment while the market was open?
They can both be essentially perfectly hedged and arbitraged with futures contracts. Normally a quarter point bid/ask gap during the day.
Of course SPY and the index and futures are all very slightly different beasts.
Implied interest rates, margin/borrowing power tied up, determined or indeterminate time frame, tax treatment on capital gains vs dividends vs futures, whether you get extraordinary dividends and changed regular dividends, etc.
Jim
No. of Recommendations: 0
None taken! I find this odd, but can't yet put my finger on "I made a mistake" versus "I learned something new today", so welcome input!
First thing to check: When you calculated this, was this a snapshot of bid/ask and index level and SPY price at the exactly the same moment while the market was open?
The data was from today (East Coast U.S.) so both SPX and SPY at close Friday, data from Schwab.
BTW, I also saw this in older data I had lying around, I just thought I'd make the data snapshot for this post timely so pulled up Scwhab options chains.
SPY seems fine, makes sense, ask is always greater than IV.
The argument for why this holds for SPY is simple: if you held SPY shares, then you can buy one of those puts, and if Ask was less than intrinsic value (IV) then you could sell the shares using the put and make money, so that gets arb'd away.
The SPX "ask" in relation to "IV" surprised me.
In the post I floated the suggestion that because you can't hold (buy or sell) SPX shares that the arbitrage argument that works for SPY, where you can hold shares, doesn't work for SPX so SPX "ask" can float around in relation to IV.
But that makes my whiskers twitch.
No. of Recommendations: 6
7/27/2024: SPY 544.22
7/27/24 was Saturday.
You cannot trust option quotes when the market is closed. The bid/ask are meaningless.
I have seen some CRAZY pre-market quotes that cleared up as soon as the market opened.
No. of Recommendations: 0
Ray, I'm not sure why close data could be screwy, but I took your suggestion and used data from this morning when the markets are open, and the same observation holds.
I rephrased the issue below, so hopefully the issue is clearer:
------------------------------------------------------------------------------------------------------------
For SPY, the "share price" plus the Ask of a put is always greater than the strike (otherwise you could make "free money", see below)
For SPX, the "share price" plus the Ask of a put is NOT always greater than the strike (note that there are no "shares" of SPX)
What's going on?
The answer is simple for SPY:
If the share price plus the Ask of a SPY put was less than the strike, then you could buy a share and buy a put and then use the put to sell the share at strike, and get more money than you paid. But arbitrageurs would get to such an opportunity before you, so you'd never see it. And you don't, I demonstrate this using a SPY options chain data snapshot below.
The answer for SPX isn't as clear:
First, the "share price" plus the Ask of a SPX put is *not* always greater than the strike (demonstrated below). At first I was surprised by this, but then tried to rationalize it by arguing that the SPY arbitrage argument doesn't hold for SPX. This is because there are no shares of SPX. You can not "buy shares of SPX" and then sell them at strike using the put and perhaps make money, simply because there are no shares of SPX (SPX has futures and options, SPX has no "shares"). Given that the SPY arbitrage argument doesn't hold for SPX, perhaps it's not suprising to see the relation that holds for SPY violated for SPX options? But it surprised me.
Below is data for SPY, showing that the share price plus the ask of the put is always greater than than the strike:
Data taken 7/29/2024 10:00 AM when SPY=546. Put expiry April 17 2025:
SPY Strike Bid 570 Ask 31.77 33.10 Price+Ask = 546+33.10 = 579.10
SPY Strike Bid 580 Ask 37.60 39.09 Price+Ask = 546+39.09 = 585.09
SPY Strike Bid 590 Ask 44.63 46.24 Price+Ask = 546 + 46.24 = 592.24
SPY Strike Bid 600 Ask 52.70 54.73 Price+Ask = 546 + 54.73 = 600.73
SPY Strike Bid 700 Ask 152.09 154.77 Price+Ask = 546 + 154.77 = 700.77
Below is data for SPX, showing that the share price plus the ask of the put is *not* always greater than than the strike (see the last two rows):
Data taken 7/29/2024 9:50 AM when SPX=5471. Put expiry is April 17 2025:
SPX Strike 5700 Bid 292.40 Ask 293.40: Price+Ask = 5471+293.40 = 5764.4
SPX Strike 5800 Bid 338.30 Ask 339.70: Price+Ask = 5471+339.70 = 5810.70
SPX Strike 5900 Bid 391.40 Ask 395.70: Price+Ask = 5471+395.70 = 5866.70 ***
SPX Strike 6000 Bid 452.10 Ask 456.60: Price+Ask = 5471+456.60 = 5927.60 ***
Am I missing something, or "don't worry, be happy" and believe the rationalization I'm trying to sell to myself?
No. of Recommendations: 0
Am I missing something,
Could it be that SPY pays a dividend and SPX does not?
The other party which is making the option quotes is a big player in the Goldman Sachs league. You can be pretty sure that they have figured it out right.
I'm not sure why close data could be screwy,
I regularly see wild option quotes when the market is closed. Not always, but often enough. Usually what I'll see is a very large spread--which tightens up when the market opens.
No. of Recommendations: 1
Another interesting thing I saw just now.
S&P 500 INDEX (^SPX)
SPX Apr 2025 5700.000 call is Bid 241.80 Ask 243.10
Volume 200 Open Interest 2.67k
but
S&P 500 MINI SPX OPTIONS INDEX (^XSP)
XSP Apr 2025 570.000 call is Bid 17.52 Ask 18.34
Volume 1 Open Interest 10
XSP is 1/10th the size of SPX, so I expected the prices would also be 1/10th, but this is clearly not the case.
WHY??? They move in tandem, so why?
Each call of SPX is $24,200 while each call of XSP is $1,800.
Looking at the volumes & open interests, SPX is what the big players use and XSP is what us pipsqueaks use.
If you wanted SPX call, why wouldn't you buy 10 of the XSP call? $18,000 vs. $24,200. What am I missing?
No. of Recommendations: 2
Ah, never mind. I was looking at the quotes from Yahoo.
Here's what I get from an actual broker.
April 17, 2025 call
SPX 5700.00 bid 236.40 ask 237.40 volume 200 open interest 2,668
mid: 236.90
XSP 570.00 bid 23.33 ask 24.20 volume 0 open interest 10
mid: 23.77
With SPX= 5470.10 and XSP=547.01, exactly 1/10'th
The XSP call is (perhaps) slightly more expensive. Makes sense, bigger players get a better price.
No. of Recommendations: 0
I recalled that SPX (and for that matter, SPY) options do trade 'after market', when presumably liquidity is lower, so one might think that could lead to wider bid/ask spreads.
I called the Schwab options desk and asked them if their data posted on their website when normal markets are closed e.g. after 4:00pm or on weekends or on holidays etc, was "close data" or if their data reflected "after market" activity?
They replied it is "close data" and does not reflect 'after market' activity.
So that ain't it for the data I was using (maybe RayVT uses a brokerage that posts after market data?)
I also gave the options desk guy one of the examples I posted here, and he checked it in real time.
"Negative extrinsic value!" he said.
Yep, that's another way to say it.
He contacted their "trade resolution desk" and apparently the reply was that "yes, you can have negative extrinsic value for SPX options". He said that he'd research it more and send me a message. The "official explanation" will be interesting.
The explanation that I came up seems correct but slightly unsettling: SPX, unlike SPY, has no shares and hence there's no arbitrage mechanism for SPX that keeps extrinsic value positive. I believe that to be a true statement, but feel like I'm missing something e.g. an expert might reply "that's true, but you neglected this".
An alternative explanation is that it's market makers just messing with our heads.
No. of Recommendations: 7
The explanation that I came up seems correct but slightly unsettling: SPX, unlike SPY, has no shares and hence there's no arbitrage mechanism for SPX that keeps extrinsic value positive. I believe that to be a true statement, but feel like I'm missing something e.g. an expert might reply "that's true, but you neglected this".
They are both easily arbitraged, and in fact both can easily be arbitraged two ways: either with futures contracts or with actual stock.
I suspect (?) part of the issue may have to do with dividends and interest.
First, recall that index options are almost exactly like futures, in that they are both cash settled "side bets" on the level of the index at some future date. Not today.
When you buy an option on SPY, you are getting an option to buy an ETF which (for practical purposes) owns stock, and pays dividends, and incidentally can be exercised any time. Consequently the current fair price of SPY is the sum of the current prices of the shares it in effect owns, which is in effect the current index level.
Conversely when you trade futures or index options you are making a wager on the movement of the index number until some future time. The index itself does not pay dividends. Nor is it something you can buy, so it doesn't tie up your cash to make a wager long it.
The current fair price of a futures contract is therefore the "current price of the stocks" number (=the current index value), PLUS the amount of short term interest till expiry on the nominal value, MINUS the anticipated dividends whose ex-dates are prior to expiry. If today's dividend yield equals the current interest rate, then the futures will trade at the index level, but as that is generally not true, there is normally a gap except on expiration day. So, the price of SPY tracks the index, but the prices of wagers on a future index value (futures and index options) don't quite. Consequently an option for one wager even at an equivalent strike should not be expected to have the same price as the matching option wager on the other.
This is a real effect, but it's not large. The longer till expiry, the bigger the gap. e.g., for March futures, the gap between current index level and current futures contract quote right now is 173 points, almost 3.2%.
Jim
No. of Recommendations: 2
Here's what a "Senior Specialist in Derivatives Trading" at Schwab wrote me, after they checked in real time during our phone call that the SPX ITM puts I referenced had significant negative extrinsic value (aka time value):
From: Schwab Client Service
Dear NAME DELETED
After further researching the pricing of in the money long term puts on SPX, I did find a couple reasons for the intrinsic value not being fully priced into the current Ask price.
The main reason will be because index options are European style which means they can not be exercised until expiration. This means the option must be held full term which will tie up some buying power whereas with stock options arbitrage could be captured by instantly exercising the option to take on the share position. This does allow for index options to sometimes be priced below the intrinsic value to consider the time factor involved.
> Above seems related to the point I made: SPX doesn't have 'shares', so you can't arbitrage SPX options with shares like you can arbitrage SPY options with shares. The share arbitrage mechanism for SPY keeps SPY option's extrinsic value non-negative. The extrinsic value of SPX options can be significantly negative, as per my examples.
Interest rates will also effect options pricing which is expressed through the option greek Rho. Calls have positive Rho while Puts have negative Rho so as interest rates increase the value of puts will be lowered while premium on calls will be raised. If you look at option prices when interest rates are lower you will see how pricing was different during these times of lower rates.
> Not sure I understand the above because Rho is an *instaneous* measure and interest rates didn't jump at the time of my examples. BWDIK?
If you have any additional questions please feel free to contact us back at the trade desk at 877-870-7271.
If you have any further questions, please start a live chat on Schwab.com or reply to this secure message. Our representatives are available at any time to assist you. We greatly appreciate your business.
Sincerely,
NAME DELETED
Sr Specialist | Derivatives Trading
Tel 877-870-7271
500 Maryville Center Dr, St. Louis, MO 63141
No. of Recommendations: 3
When you buy an option on SPY <snip> incidentally can be exercised any time.
I don't think "exercised at any time" is an incidental point -- it's the whole point.
Because you can exercise an American style SPY option at any time, then a SPY ITM put's time value (aka extrinsic value) must be non-negative. Otherwise you could buy 100 shares, buy an ITM put contract, and immediately exercise the ITM put to sell the shares at strike (which is higher than the share price for ITM puts), and make "free money". The 'ask' will quickly rise to stop people making 'free money'.
But a European option has no early exercise, it's cash settled on the expiration date, hence the above process doesn't apply.
I haven't worked out an arbitrage argument using futures to show this, but I'm betting that the resolution to the examples I showed where ITM SPX puts have "negative time value" is:
What is relevant at any time before expiration of a European option is not the price at that time relative to the strike, but rather the price at that time relative to the discounted value of the strike.
By 'discounted value' I mean the value you'd have to put into a risk free asset today to have the value of the strike at expiration. The broad point (that admittedly I haven't fleshed out) is that the only thing European options care about is expiration. So, if you want to talk about "extrinsic value" or whatever before expiration, then you need to discount stuff back from expiration.
I tried the 'discounted strike' idea on the examples that had negative extrinsic value (time value), and it fixed them.
