Question about intrinsic value vs time value

nooby_mcnoob · Jul 9, 2019

Ignoring everything else:

time value = option price - intrinsic value

I'm trying to understand what this plot is showing me. It looks to me like calls have a slightly higher time value than the equivalent puts for the same expiry. What are the various explanations for this? My initial instinct is that the market thinks that SPY is going higher over the next 90 days?

drm7 · Jul 9, 2019

This is probably not a technical enough answer, but puts are almost always more expensive than calls at any given strike (which by your equation would result in less time value). I'm sure there are several PhD papers that explain why that is, but it's sort of accepted now.

nooby_mcnoob · Jul 9, 2019

drm7 said:
This is probably not a technical enough answer, but puts are almost always more expensive than calls at any given strike (which by your equation would result in less time value). I'm sure there are several PhD papers that explain why that is, but it's sort of accepted now.

The less technical the better :-)

destriero · Jul 9, 2019

Dude, you worked at Bridgewater? In what capacity?

Opshuns 101.

Calls are the revenue side of the arbitrage. If you don’t understand that then I suggest reading Hull, et al.

You can think of the share forward as embedded in the call. If shares are at 50 and the one year forward is at 51.5, then the 50C will be priced 1.5 more than the 50P, absent dividends. I am wondering how you arrived at excess premium in the calls relating to a higher market. Really?

Imagine if STIRs were at 8%! Market be done goin’ to Pluto!

Same strike calls and puts must trade at =vols or arbitrageurs will short you overpriced calls, buy the underpriced puts, and go long shares. The conversion arbitrage.

destriero · Jul 9, 2019

Further, there is 300bp in the 25D risk-reversal, favoring the puts. Has been since 1987. Does that mean the market should crash?

ETJ · Jul 9, 2019

Go to the net - get a pricing model and price an exactly ATM. The difference between the call/put price is net carry. Calls have carry - puts have rebate - assumes no dividends, corporate action or differences in volatility. Dividends make calls cheaper and put more valuable. There can be a ton more details like hard to borrow where the put would be worth more than the call, because you're paying to borrow instead of getting a rebate. Go price some pairs and you sell how the variables change the output. Call prices are normally higher than puts. Put/Call parity say stock+put-call= carry. The relative pricing model works when can be borrowed and lent and the underlying can be easily bought/sold.
Play with a model first and come back if you have more questions. There are all kinds of details that can screw this up, but the easy answer calls are a surrogate long and have carry - puts are a surrogate short and have rebate.

nooby_mcnoob · Jul 9, 2019

destriero said:
Dude, you worked at Bridgewater? In what capacity?

Opshuns 101.

Calls are the revenue side of the arbitrage. If you don’t understand that then I suggest reading Hull, et al.

You can think of the share forward as embedded in the call. If shares are at 50 and the one year forward is at 51.5, then the 50C will be priced 1.5 more than the 50P, absent dividends. I am wondering how you arrived at excess premium in the calls relating to a higher market. Really?

Imagine if STIRs were at 8%! Market be done goin’ to Pluto!

Same strike calls and puts must trade at =vols or arbitrageurs will short you overpriced calls, buy the underpriced puts, and go long shares. The conversion arbitrage.

No I didn't, I used to live in Bridgewater, NJ :-)

Also, after reading your opshuns 101... Duh

ETJ said:
Go to the net - get a pricing model and price an exactly ATM. The difference between the call/put price is net carry. Calls have carry - puts have rebate - assumes no dividends, corporate action or differences in volatility. Dividends make calls cheaper and put more valuable. There can be a ton more details like hard to borrow where the put would be worth more than the call, because you're paying to borrow instead of getting a rebate. Go price some pairs and you sell how the variables change the output. Call prices are normally higher than puts. Put/Call parity say stock+put-call= carry. The relative pricing model works when can be borrowed and lent and the underlying can be easily bought/sold.
Play with a model first and come back if you have more questions. There are all kinds of details that can screw this up, but the easy answer calls are a surrogate long and have carry - puts are a surrogate short and have rebate.

This makes sense now, thanks.