Underpriced SPX options at expiration

Sig said:
Thanks for bringing this up @FSU. For those out there that have been an options MM, do you make a market right up to expiration? If not, when do you generally stop quoting? I would think the models would start to break down a few minutes before expiration?
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It depends on what market you trade.

For instance, on the AEX index... you are obliged to quote until the end, and their expiration level is determined by the spot levels at every 1 minute between 3.30 and 4 pm. Single stocks you have to quote until the end of the day at expiry.

Options on Eurex are again different, and you don't have to quote each series until the end... so you can opt-out of quoting the front month... (or so it used to be).

I never wanted to have a position in the ATM strike on the last day, not even conversion or reversal, since pin-risk is a big risk. So... I would only take a trade if it would make sense and pinrisk was out of the equation.

Premium decay in the index is too big on the last day ... but the risk is almost to big as well... never really bothered to trade it very actively anymore.

Most professionals would move on to the next month at start of the week anyway, so the only interesting trades are usually people closing out ITM's... they are fun to trade, since they tend to go under parity or way above a lot... hedged with delta 1 and if it's further OTM there's not much risk.
 
JackRab said:
It depends on what market you trade.

For instance, on the AEX index... you are obliged to quote until the end, and their expiration level is determined by the spot levels at every 1 minute between 3.30 and 4 pm. Single stocks you have to quote until the end of the day at expiry.

Options on Eurex are again different, and you don't have to quote each series until the end... so you can opt-out of quoting the front month... (or so it used to be).

I never wanted to have a position in the ATM strike on the last day, not even conversion or reversal, since pin-risk is a big risk. So... I would only take a trade if it would make sense and pinrisk was out of the equation.

Premium decay in the index is too big on the last day ... but the risk is almost to big as well... never really bothered to trade it very actively anymore.

Most professionals would move on to the next month at start of the week anyway, so the only interesting trades are usually people closing out ITM's... they are fun to trade, since they tend to go under parity or way above a lot... hedged with delta 1 and if it's further OTM there's not much risk.
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Thanks, that's very helpful. No pin risk on SPX since it's cash settled right, or am I missing something on that (I assumed you were talking more generally but assuming you understand something can be dangerous!)
 
Sig said:
Thanks, that's very helpful. No pin risk on SPX since it's cash settled right, or am I missing something on that (I assumed you were talking more generally but assuming you understand something can be dangerous!)
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Yeah, for cash settlements it's not a risk... :thumbsup:
 
FSU said:
I was a MM for 25 years in the OEX, quoting electronically for the last two of those years, before I left the floor. For the time I quoted electronically, I would stop about 10 minutes before the close on expiration. You are right, the models broke down in the last minutes of trading on expiration as prices are now driven by the underlying rather than futures. This really gives you some interesting opportunities today in the indexes like the SPX, especially in the last 30 seconds or so of trading, where the MM's model is not modeling the change in the underlying properly.
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Can you elaborate on why MMs stop quoting 10 minutes before close? Is it common for options MMs to stop quoting a little before the markets close? Last question; does this strategy work with stock options rather than indices?
 
Moon said:
Can you elaborate on why MMs stop quoting 10 minutes before close? Is it common for options MMs to stop quoting a little before the markets close? Last question; does this strategy work with stock options rather than indices?
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I don't think most stop quoting 10 mins before the close, I was saying I did. It is much harder to accurately price cash settled index options, such as the SPX and OEX, in the moments before the close on expiration. Normally the options are priced off the SP futures, but the price/direction of the index is what matters at the very end of the day on expiration.

The opportunity I was speaking of related to indexes such as the SPX, not equities.

Also, didn't work today.
 
Moon said:
Can you elaborate on why MMs stop quoting 10 minutes before close? Is it common for options MMs to stop quoting a little before the markets close? Last question; does this strategy work with stock options rather than indices?
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No, not 10 min before the close, 10 min before expiration.

There are/were reasons special to SPX - by that time, options are pricing off cash stocks and there is potential for some deviation. It’s less so today, as there is a lot of people trading “match cash close” in futures and MMs use that to their advantage.

Nonetheless, exipiring index options usually have a very light book because it’s hard to monetize (what’s “vol” if you have prices similar in magnitude to min tick) and easy to get pinned (since it’s cash, pin would mean becoming naked at cash close and scrambling to trade your delta into futures close).
 
@Moon, in addition to what @FSU said... the entire last day of expiration, your models don't really work. You just look at what the straddle value is... look at direction, where your risk is and generally limit exposure. The expiring month isn't really hedged anymore by the next expiration months either. vega is zero, gamma is extreme at the ATM... therefore delta's can change rapidly... so the expiring month is basically non-hedgable...

If you're still quoting until the end, you expose yourself to all sorts of things.

I remember a Swiss stock, can't remember which one... I think it was some smaller pharmaceutical.. but not tiny. We we're quoting the expiry and got lifted out of the blue on fairly large size in an OTM call right before close... 'hedged' a little bit, but it was 2 or 3% OTM on expiry, with only the closing auction left. So... of course in the closing auction the stock gets lifted right through the strike... about 15% or so... massive loss... we partially hedged in the auction (at the high of course, since it's an auction). Rumours hit right after about a possible takeover... we buy some more stock OTC... We had some other OTM calls as a long position and of course ITM puts, but what do you do?? Exercise or not? If all shorts got assigned, we would be short delta on Monday... takeover would hurt even more... if we would exercise some further long OTM calls to get long delta, you take the gamble of a takeover... it's still rumours...

Next Monday, stock opens only about 8% higher compared to pre-auction.. (so basically lower compared to the prev. close)... so we made back some money, but it still hurt...

There's plenty of other anecdotes... after the Lehmann collapse, can't remember the exact timeline, but also on expiration before European markets opened in September or October news of intervention came out... European banks skyrocketed on expiration day... 20-30%. Indices like DAX and AEX went up 6-10% at the open! If you don't have your shit together and have all sorts of open OTMs... that can really really hurt. We had positions in certain stocks that lost 1-2 million... and made that in other stocks. Company wide we made very good money, but some individuals we're not exactly enjoying... luckily we traded as teams, so no real pain individually.

Moral of the story.... trading the expiry month on the last day is pretty much a gamble, so why run large risks for pennies....
 
FSU said:
Crazy moves in the last minute in SPX. .10 puts go to 1.40 in one minute.
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If only you could bet the farm, and repeat that five times compounded -- you would be able to retire, o_O in Monaco and hangout with the world's Elite.
You could tell people you made your fortune in the shock market.

The trick and skill, however, is being able to predict/manage the here and now...not the future in hindsight.
 
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