SPX options
- Thread starter FSU
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It was not only byzantine but deeply flawed mathematically and commercially. I had emailed the Director of CBOE on October 29, 2015 expressing my frustration about all three options series and suggested that they merge SPXPM with SPXW into one series.
At the end of the long discussion, the Director promised me that my comments would be given proper consideration. It took them a while but am glad they finally acted on it.
See an excerpt of my email chain dated 10/31/2015 below for more details on why I called it a "Major flaw in SPXW":
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Hi Mike. Thanks for your prompt response but I’m sorry to say that your reasons do not make sense to me.
With the recent introduction of PM settled SPXPM options, CBOE has been successfully operating both AM and PM expirations on every 3rd Friday of every month since 2012 on the same underlying index.
I know that these two option types are not part of the same series. What stupefies me is why CBOE has chosen to include PM settled SPXW weekly options in the same series as AM settled SPX options. This options series is a mathematically and commercially flawed product that underserves customers like myself who trade volatility surfaces for a living. This options series creates an unnecessary singularity, a black hole if you will, in the volatility surface implied by SPX and SPXW options on every 3rd Friday of every month ad infinitum.
More importantly, CBOE is losing money on this black hole riddled SPX series because horizontal spreaders like myself avoid this options series on the 2nd and 3rd weeks of every month (because AM settled SPX options will be involved in the front and back weeks of any horizontal spreading strategy). AM settled SPX options are a legacy product and I avoid it like the plague.
I know that AM settled SPX options have the most amount of volume right now because its been around for decades. I believe that its use will decline over time as more people become aware of the alternatives. I don’t know any retail or professional trader who likes to wait around for hours to find out the SET value every 3rd Friday morning. It’s a bizarre process and very trader unfriendly. Not to mention that it is still pit traded and has bid/ask spreads that are shamelessly so wide that you can drive a truck through it.
The logical and mathematically correct choice is to include the PM settled SPXW weekly options with the PM settled SPXPM monthly options and make them part of the same series. This gets rid of the unnecessary 3rd Friday black hole and creates a smooth volatility surface implied by this modified options series.
Without introducing another option type, I believe CBOE has two simple solutions to solve this problem:
1. Substitute AM settled SPX options with PM settled SPXPM options in the current weekly SPXW options series. This isolates AM settled SPX as a separate series (a simple swap).
2. Include SPXPM in the current series with SPX and SPXW options so brokerages can allow us the choice of horizontal spreading with SPX or SPXPM options in the 2nd and 3rd weeks of every month.
I hope CBOE will make these simple changes and rectify a deeply flawed product, increase customer satisfaction and enhance its own revenue streams. Thanks.
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Sorry, just noticed this - what exactly do you mean by "flawed mathematically"?
The mathematical flaw has to do with the volatility surface implied by the previous SPX/SPXW series and is clearly exposed by a simple, consistent weekly long calendar strategy.
If you have a strategy that requires you to put on weekly long calendars where the difference between the short option expiration and long option expiration is 7 days, you could not implement your strategy consistently with the previous SPX/SPXW series.
On the 2nd and 3rd weeks of every month, your long weekly calendars would be 6 days apart instead of 7 days, which clearly affects the greeks. On the third week, unlike all other weeks, you could not hold your calendar beyond Thursday even if you wanted to because SPX would stop trading and you would be long a naked option at the open and at the mercy of the SOQ (Special Opening Quotation) procedure.
Worse, many retail brokers would not increase your buying power even though the short SPX option had expired. They would insist on waiting until they got the official SET value, which requires all the 500 stocks in the SPX to trade for the value to be computed. Sometimes it could take hours.
For the third Friday of every month, you could not use SPXPM as your short option and SPXW as your long option because they were not part of the same option series. Only a couple of brokers I talked to were willing to cross margin the two series even though the underlying is the same index!
Even if your broker agreed to cross margin the two series, you could not find a good software platform that would let you construct such a calendar spread using SPXPM/SPXW symbols!
A mathematically sound options series will allow you to easily implement a consistent, simple calendar strategy using any two weeks you may like, ad infinitum. There was never a problem with SPY weekly options series. And now you won't have the same problem with the new SPXW series.
If you have a strategy that requires you to put on weekly long calendars where the difference between the short option expiration and long option expiration is 7 days, you could not implement your strategy consistently with the previous SPX/SPXW series.
On the 2nd and 3rd weeks of every month, your long weekly calendars would be 6 days apart instead of 7 days, which clearly affects the greeks. On the third week, unlike all other weeks, you could not hold your calendar beyond Thursday even if you wanted to because SPX would stop trading and you would be long a naked option at the open and at the mercy of the SOQ (Special Opening Quotation) procedure.
Worse, many retail brokers would not increase your buying power even though the short SPX option had expired. They would insist on waiting until they got the official SET value, which requires all the 500 stocks in the SPX to trade for the value to be computed. Sometimes it could take hours.
For the third Friday of every month, you could not use SPXPM as your short option and SPXW as your long option because they were not part of the same option series. Only a couple of brokers I talked to were willing to cross margin the two series even though the underlying is the same index!
Even if your broker agreed to cross margin the two series, you could not find a good software platform that would let you construct such a calendar spread using SPXPM/SPXW symbols!
A mathematically sound options series will allow you to easily implement a consistent, simple calendar strategy using any two weeks you may like, ad infinitum. There was never a problem with SPY weekly options series. And now you won't have the same problem with the new SPXW series.
I think the only good reason that AM settled options are still around is that it enables pit traders on the CBOE to make a killing from artificially wide spreads and unsuspecting or panicky traders
Any financial instrument that is not transparent and has an inside narrower spread available to a few and not the general public is highly suspect. It's a travesty that one of the most liquid options in the world is still pit traded and shamelessly displays such wide bid/ask spreads. Only a monopolist could do that and get away with it. It can't be good for the general public.
The Emini futures and VIX options were invented after the SPX am settled options (it baffles me why the SP futures expire a couple hours earlier than the AM settled options - nobody cares about those illiquid, pit traded contracts anyway).
You could easily get rid of the SPX am settled options, have the VIX calculated from SPXW options and have the e-mini futures settle on the close on Fridays.
There is nothing special about this am settled series with its excruciating SOQ procedure. It could be easily replaced if CBOE wanted it. But I'm sure they will milk this cash cow for as long as they can.
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I still don't see any "mathematical flaw". Yes, it's an option that expires at a different time of the day which adds another quirk. What exactly prevents you from implying volatilities using properly calculate business day-fraction? You are trading volatility surface, so make a proper volatility surface model.
I'm not sure I understand your point either. The quirk is the flaw. There is an actual hole in the volatility surface and it was not possible to trade it, at least not easily. So what's the point of making a proper volatility surface model? Theory that doesn't support my trading is useless.
RFQ-style market has it's purpose. SPX options are primarily an institutional market and most institutions trade tied. As a PM at a large fund, I can call my coverage and they'll quote me a million vega tied in a matter of seconds. Not a pedestrian size, but nothing out of the ordinary. I'll probably pay inside of half a vol, possibly a quarter. Now, for single stocks, BDs have adopted by doing the whole quote-cross-print cycle, but the fact that you can get tighter then the screens is also true there.
Electronic market makers would not even touch that stuff, try executing the any real size electronically in SPYs and tell us how it went
LOL. A "hole"? You have options expiring every couple days and one of them, coincidentally, expires in the morning. What exactly prevents you from trading that spread, is it the fact that it's inconsistent with your backtest or something?
PS. The pit absolutely has to go, but I think moving it from RFQ to pure AMM-driven will just move the RFQ process to IBs for those with access and will make others (without BD coverage) very unhappy
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Backtesting? I trade options spreads for a living and have been doing so for almost a decade. That's when you realize how a little mathematical quirk can lead to significant financial losses in real life trading.
Until very recently, you did not have SPX options expiring on Wednesdays or Mondays. It was only Fridays and the 3rd Thursday of the month. This quirk didn't prevent me from trading calendar spreads - it just made it annoying for me to do it consistently as I explained earlier.
Anyway, after a lot of calls to brokers and software vendors, I even tried to trade SPXW/SPXPM as a spread in Feb 2016. However, I got screwed doing this spread because while I was able to put on the calendar using a specialized, but user-unfriendly piece of software, I had to leg out of the spread later with the market going against me because nobody seemed to be willing to take the other side of the SPXW/SPXPM calendar spread. This is exactly what I was hoping to avoid.
I lost quite a bit of money on this trade. I shouldn't have had to do these antics for a simple calendar strategy if CBOE had designed the series correctly as I explained in my letter to the Director. Clearly, they saw my reasoning and have changed the series so it does not have any type of quirks.
After that experience, I started trading calendars using SPY options which did not have this problem to begin with (but had other issues).
Until very recently, you did not have SPX options expiring on Wednesdays or Mondays. It was only Fridays and the 3rd Thursday of the month. This quirk didn't prevent me from trading calendar spreads - it just made it annoying for me to do it consistently as I explained earlier.
Anyway, after a lot of calls to brokers and software vendors, I even tried to trade SPXW/SPXPM as a spread in Feb 2016. However, I got screwed doing this spread because while I was able to put on the calendar using a specialized, but user-unfriendly piece of software, I had to leg out of the spread later with the market going against me because nobody seemed to be willing to take the other side of the SPXW/SPXPM calendar spread. This is exactly what I was hoping to avoid.
I lost quite a bit of money on this trade. I shouldn't have had to do these antics for a simple calendar strategy if CBOE had designed the series correctly as I explained in my letter to the Director. Clearly, they saw my reasoning and have changed the series so it does not have any type of quirks.
After that experience, I started trading calendars using SPY options which did not have this problem to begin with (but had other issues).
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