Put going OTM and greeks?

Discussion in 'Options' started by a529612, Sep 25, 2007.

  1. MTE

    MTE

    Yeah good point.
     
    #11     Sep 27, 2007
  2. Lar,

    You’re correct I wrongly assumed we were discussing Equity markets. I am sure there are markets where the skew is opposite.


    Neo,

    Even Euro style deep in the money puts don’t really trade below true intrinsic value. They do trade below what the generic idea of intrinsic is. Something like an SPX put which is cash settled Euro style appears to be below parity but its not below intrinsic since the proper hedge is the long term future. You buy the put and you technically should be buying the long term future which decays over the life of the put. If you can figure out a way to hedge the delta of the deep SPX put with a vehicle that does not decay, I suggest you do it in huge size.
     
    #12     Sep 27, 2007
  3. Grant

    Grant

    Xflat,

    You’re right, I do have that one backwards. This is what happens when it’s way past one’s bedtime (is that OK as an excuse?). Thanks for the correction.

    “Conversely, if implied drops, your time value will decrease at a greater rate than normal time decay”. Definitely lack of clarity here. Need to determine what I’m trying to say.

    My point of reference was European-style index options. Occasionally, calls will trade below intrinsic value. However, being so deep in-the-money I can’t see any advantage – or point - in using these, nor do I see an arbitrage.

    For example:

    5000 strike
    call premium: 2,895
    underlying: 7945
    days: 175
    rate: 4%
    intrinsic value (discount): 5000+2895-7945=-50

    These values were from DAX options, 21 Sep 07 (Last Trade), 20 lots. There were other examples.

    Arbitrage:
    long 5000 call at 2,895
    short future at 7945.

    Regardless of outcome, at expiry the net gain will be 50 points. If the opportunity cost of carry (for the call) at –56 is included:

    2895 – (2895 x e^(0.08 x 175/365)) = -56.

    50 – 56 = -6, or no arbitrage. Presumably, the future’s margin cost should also be accounted for.

    Is that correct? Should there a greater than 1:1 ratio?

    Grant.
     
    #13     Sep 27, 2007
  4. Grant as I mentioned in my previous post. Euro sytle options appear to trade below intrinsic only because the difference in what you precieve to be intrinsic and where those trade is made up in the cost to cary the hedge.
     
    #14     Sep 27, 2007
  5. Grant

    Grant

    Xflat,

    Thanks for the clarification.

    Grant.
     
    #15     Sep 27, 2007
  6. European style equity calls can trade below intrinsic where a dividend is due prior to expiry.

    For example,

    Spot 500
    Dividend due 25
    Dividend paid 1 week
    Options expiry 2 weeks
    480 strike call could priced at 5

    American style options however, will never trade below intrinsic.
     
    #16     Sep 29, 2007