Every option has an assymmetrical return profile - you play the fixed premium again a variable payout. In these terms, trading straddles into expiration is not different from any other option trades held to expiration (or any other event trades like earnings plays, for that matter). If the risk is statistically mispriced, it's worth a trade - you can always scale it accordingly.
Correct.. But this is different because the options stop trading on Thursday but settle on Friday based on some complicated formula that you have no control on. For example, when you trade Iron Condor with deltas 10-15, your risk/reward is also pretty bad - you usually risk about $8 to make $2. But you can control your risk by adjusting or closing before expiration so you never lose the maximum theoretical loss.
I would only say that "adjustments" or closing before expiration do not change the overall expectation of the strategy. If anything, trading anything worsens your expectation unless it's an original part of the strategy (e.g. you delta-hedging). This one is no different then any actuarial strategy, e.g. earnings plays.
Hi, I too was burned big time when the SET price came in so high. I sent emails to standardandpoors.com complaining, and they sent a file to me with all 500 stock opening prices that were used for the calculations. They also sent the formula, but it is vague and they wouldn't provide the exact formula. I set about finding each stocks' opening price based on other data providers. Being a programmer, I wrote a small java app that pulled the prices from Yahoo, which I think can be relied upon. I then created a spreadsheet based upon this info. I would say that 80% were lower than the prices that Standard and Poors used. At first they seemed a small pct, but after totaling, averaging, etc. the discrepancies could be the reason for such a high SET price. I found that the total of price discrepancies was 94.79, which is .05 % of SPX high price of 1883.98. If you take the difference between the SET and actual highest price of the SPX, you get 9.32, which is .0049 % of SPX high price of 1883.98. More than enough to be inaccurate. In fact 10 times higher. I'm not sure what to do about this, but I had 100 1880/1885 call credit spreads working and I lost a lot of money. And considering Thursdays close, Friday's open and close, I believe that I and many others erroneously lost money. If anyone would like the spreadsheet, send me a private message. I would like to pursue this further, especially with those who lost money because of this anomaly. Most likely the only way to make this right is a lawsuit, but if it resulted in your account being made right, it would be well worth it. Besides, it is high time that this method of setting the closing price for SOME indexes be put out to pasture.
It's not an anomaly and it's not a complicated formula. It's very simple actually. They use the exact opening price of all 500 stocks multiplied by the exact weighting that stock has in the index to create a synthetic index called SET. That SET gets reported usually by noon of the settlement day but can take longer. The reason you have to wait for SET is because some stocks can have delayed openings. I've seen stocks open two hours after the open! Now, there is a very important nuance you HAVE to understand about this math. The SET price is HIGHLY dependent on what the overall market is doing at the EXACT time of each stock's opening. Let me give an example. Let's say we have an index of 500 stocks. And only 100 open at 8:30 central time and the overall market is flat on the open so you figure SET will be relatively flat. But remember, 400 stocks are not open yet for whatever reason and don't open for another 30 minutes in this example. Let's say 25 minutes into trading some data gets released and this index spikes 20 handles. After the spike the rest of the 400 stocks finally open only now, these stocks opened at MUCH higher prices due to this sharp rally. The SET price in this example will be substantially higher then the open price. In fact, if you can follow the math, you will understand that it could be even higher then the 20 handle spike? Can you deduce why? It's because the 20 handle rally is including the prices of the 100 stocks previously opened. The other 400 stocks as a group represent a much larger move. It could be as high as 30 handles higher. So to review this. Index open flat. But this is not SET. Index rallied 20 pts higher by the time all the stocks finally opened. But this price is also not SET. SET is actually a price higher then both and in fact, can be a price that never actually trades at all over the given day. A few more housecleaning items here. Option premiums WILL reflect this price risk. It will cause them to appear overpriced. Second, the worst SET we ever had was Sept 2008 when minutes before options settlement the FED put a ban on short selling financial stocks. The Russell 2k went out at 691 on Thursday evening. It settled at 763 the next day! The SPX settled about 80 handles higher (can't remember the exact number). The tidbit here was right after the market opened, both indices tanked. One more tidbit, those prints were the highs before the crash. RUT eventually printed around 335 or so within months.
Thanks for this detailed explanation. I found that explanation somewhere on the internet, but the market did not spike higher 20 points or so at anytime during the day. The only spike was at the opening. It hit it's high first thing (up $9 and change), then trended downward for the rest of the day. Looking back over the last 10 years of SET prices when they were out of line by more than 4 or 5 points, you can see that the March 2014 was out of line by almost double anything previously. In this day and age, I can't understand why it's still used, especially now that they have SPXpm which settles on the close of Friday. What the heck is so hard about setting on the close of the last trading day, which is Thursday?
I'm not sure what data you are looking at but the values have varied a LOT over the last 10 years. And the spike you had on the open is MORE then enough to throw everything off. You have to understand something. Stocks can have very erratic opening prints. For example even a stock like GE could open .50 higher and then immediately trade back down to unch in seconds but that .50 print is going into the calculation. Second, why do they do this. Think about it. For the reason I just mentioned. Options are used as a hedge. What about those people who were short the market on Sept 2008. They needed to buy protection so they bought the calls. Had those calls expired Thursday on the close they could have been wiped out. That was the closest thing we ever had to an upside black swan. Thursday PM settlements make no sense to me unless you want to suggest we should also have Wed, Tues and Mon pm settlements. I mean why Thursday? It's arbitrary isn't it?
Relying on something you're not sure about is usually a good place to check for mistakes. In this case, you should probably be sure. SET prices more than likely use the listing exchange open price. Eg., for GE this would be NYSE. From pulling up a few quotes from today, it looks like Yahoo doesn't use the listing exchange open, rather what looks like the first regular hours trade from any market center. I would bet money that this is where your discrepancy is coming from.
Thanks - these are things that will definitely help in my research. One thing for sure, I will NEVER trade SPX on monthly expiration week unless I use SPXpm. The SET method stinks to high heaven. I'm sure I'm not the only one who feels that way. Ask some of the folks that started this thread. I appreciate all the comments and info.