Powerful SPX options arb with $9K instant profit and a free hedge

[guru]

Lol, you just discovered that SPX forwards correctly price for anticipated dividends. How exactly do you expect the June 2023 $600 call to be priced on the Sept 2021 expiration date?

Yup, and not just that, but forwards/futures can be priced differently for variety of reasons, also including cost of carry / interest rate, volatility (VIX), future expectations, and other factors.
And ToS assumes they’re mispriced, so I just wanted to show an exaggerated example of how ToS options graphs can be wrong, and how people can be using those charts and thinking they’ll make money, even with simple calendars, while losing in the end. While the P&L can be wrong due to dividends, and generally the options being priced off of futures/forwards and not the current price. VIX is a more common trap, but many people may not realize they can be looking at wrong P&L on SPX too, thinking that supposedly these options are European and can’t be exercised, so they don’t have any dividend risk or influence. SPY and any other options on dividend-paying stocks can be wrong too, including shorter periods of time that people often chart.

 

[dorietrading]

Nice example!

 

[JSOP]

Yup, and not just that, but forwards/futures can be priced differently for variety of reasons, also including cost of carry / interest rate, volatility (VIX), future expectations, and other factors.
And ToS assumes they’re mispriced, so I just wanted to show an exaggerated example of how ToS options graphs can be wrong, and how people can be using those charts and thinking they’ll make money, even with simple calendars, while losing in the end. While the P&L can be wrong due to dividends, and generally the options being priced off of futures/forwards and not the current price. VIX is a more common trap, but many people may not realize they can be looking at wrong P&L on SPX too, thinking that supposedly these options are European and can’t be exercised, so they don’t have any dividend risk or influence. SPY and any other options on dividend-paying stocks can be wrong too, including shorter periods of time that people often chart.

Aw you are so bad! I was just about to set up this trade and dreaming about the $10K riskless profit. Why did you have to wake me up from my dream?? Why??!!

 

[AKJ]

Yup, and not just that, but forwards/futures can be priced differently for variety of reasons, also including cost of carry / interest rate, volatility (VIX), future expectations, and other factors.

really throwing the kitchen sink at this one aren't you? Pretty sure the forward for SPX is going to be priced based on interest rates and expected dividends.

 

[guru]

really throwing the kitchen sink at this one aren't you? Pretty sure the forward for SPX is going to be priced based on interest rates and expected dividends.

So at least interest rate & dividends, but future expectations of dividends also depend on the future expectations of the index level (implied dividend is not a straight line). Volatility levels at different strikes with smile & skews also play a role.
I'm also not sure if some firms don't do detailed evaluation of SPX constituents that are affected by earnings and FDA decisions.
Anyway, have you tried getting implied dividend out of SPX (which should include borrow costs and those "other factors") - I couldn't get anything worth understanding or smoothing, but haven't spent much time on it.
While everyone gets amused with changes of vol surfaces, with a science of studying it, not deciding how someone wants it to look. (Emanuel Derman: "There are no reliable theorems in finance; it’s not math, it’s the world.")

But for practical purposes the main risk is indeed in dividends, because it can show wrong P&L even at shorter time frames and seemingly an "obvious" strategy may work differently than what's shown. I think that TDA/ToS could show better P&L if they at least used forward price, while right now they show instant profit.

 

[AKJ]

yes, I pull implied dividends from the SPX chains every day. It is not difficult.

I agree - off-the-shelf software may make it seem like a trade like this is a slam-dunk profit opportunity, and it would be great if it provided a better projection. But this is off-the-shelf software that is free and designed to work for both european and american options, so the user needs to understand the situations where a risk-graph can be relied on and where it can't.

You are again throwing the kitchen sink at the question of "how to calculate a forward price". Explain to me exactly how (1) variance in dividend expectations, (2) IV structure of underlying, (3) borrow costs, (4) and "other factors", impacts the determination of the SPX forward? Because I'm pretty sure none of these are relevant.

 

[taowave]

Hmmmmm

You are in the Sept/21 600 - 2300- 2830 1x3x4 call fly and long the June/23 / Sept/21 600 calendar spread for an 18.10 debit?? For shits and giggles,where are you pricing the calendar??

Not sure why you are long the time spread or trading the calls as your pricing is wishful thinking.

With that said,I dont trade SPX options,so I dont know the nuances,but i do know you wont get that trade on for an 18.10 debit without a very lucky leg job

Or is it?
The chart below shows $9K instant profit/mispricing, but may be an example of being mislead by these type of charts, and this can happen with many option setups.
I suspect I know what's wrong with this picture, but let you figure this one out.

View attachment 265257

 

[guru]

Hmmmmm

You are in the Sept/21 600 - 2300- 2830 1x3x4 call fly and long the June/23 / Sept/21 600 calendar spread for an 18.10 debit?? For shits and giggles,where are you pricing the calendar??

Not sure why you are long the time spread or trading the calls as your pricing is wishful thinking.

With that said,I dont trade SPX options,so I dont know the nuances,but i do know you wont get that trade on for an 18.10 debit without a very lucky leg job

No, I'm not in it. Just showing an extreme example of ToS using single SPX price for all expirations, and charting wrong P&L for those options. SPX gets cheaper with time due to lack of dividends that SPY gets, so you can buy a DITM LEAP option on SPX for less than near-term expiry. Basically a Calendar for negative price, even when buying it at the ask:

Similar to what happens with VIX options, but it's more difficult to see that on SPX options that everyone treats as equivalent to SPY.

 

[guru]

yes, I pull implied dividends from the SPX chains every day. It is not difficult.

It's not a static value (same for all strikes), right?
This topic is also discussed by quants here:
https://quant.stackexchange.com/que...rest-rate-for-put-call-parity-is-not-constant
"You are making an assumption of constant dividends, which, for longer-dated expiries is wrong. E.g. when you trade a dividend swap, do you assume zero underlying delta? As I said before, the markets "convention" is somewhere between constant and proportional dividends. It is even more complicated because of the dividend growth assumptions past the announced dividends. You can easily prove it to yourself - go to your bloomberg, download the Dec14 strip and calculate forward prices from put/call parity. You would be unpleasantly surprised."

You are again throwing the kitchen sink at the question of "how to calculate a forward price". Explain to me exactly how (1) variance in dividend expectations, (2) IV structure of underlying, (3) borrow costs, (4) and "other factors", impacts the determination of the SPX forward? Because I'm pretty sure none of these are relevant.

Sorry, I might've mixed up the forward with options prices in general, as my trade incorporated a diagonal that can be affected by volatility, and therefore supply/demand with everyone pricing it on their own.

 

[AKJ]

I don't know man, this is the March'22 SPX implied forward for a range of strikes. It's tight enough for me not to worry about whether or not the market is using a dynamic dividend assumption.