SPX / SPY Options Arbitrage?

Discussion in 'Options' started by arizonadreamer, Jan 22, 2007.

  1. I don't know if anyone has discussed this idea so here goes:

    What does everyone think about the idea of buying deep in the money SPX options (European exercise, big discount) and selling SPY options (10 SPY for every 1 SPX)?


    Buy 1 SPX (1423.5) Dec 09 1900 put at 318
    (discount of 158.50)

    Sell 10 SPY (142.28) Dec 09 190 puts at 47.80

    The disadvantages:

    1) SPX and SPY might not correlate 100%.
    2) SPY options are American style and can be early exercised.
    3) Brokers will likely consider SPY options uncovered thus requiring additional margin.

    Of course, you can always attempt to prevent early exercise by choosing options less in the money?


  2. Remember that SPY pays dividends on the first 15th of each quarter. The relationship between SPX and SPY is therefore dependent upon where in the cycle of dividends we currently are.

    A quick spread chart of SPX vs 10SPY will show you the quarterly tendencies.

    You'll have to account for one market being cash and the other being a synthetic future (through dividends).
  3. Seems to be almost a 1:1 correlation over a long period of time.

  4. MTE


    European-style deep ITM put options always trade at a discount to the intrinsic value due to the unavailability of early exercise. The difference is equal to the cost of carry to expiry, so as the time to expiry decreases so does the discount. This is not an arb opportunity!
  5. "This is not an arb opportunity!"

    But is it an opportunity?

    1:10 contracts brings in 16,000 for 3 yrs. You get interest on that amount, and if the SPYs are considered uncovered, your margin is around 40K plus.

    A 25% return over 3 years + interest if you look at it that way, provided there is no early assignment.

  6. Ooops, make that 16K on 40K would be 40% return or 13%+ a year, no?

  7. And if you are assigned?

    I have to agree with MTE this is not an opportunity. Although the contracts are somewhat similar the risks are very different.

    Not trying to be an ass, but something so obviously noticeable would not be so readily available if it were an, "opportunity."
  8. MTE


    Well, that's the problem. 190 put trading at 47.80 with the SPY at 142.28, which means it is trading 0.08 above intrinsic. You can rest assured you'll be assigned!
  9. Yes, I realize that assignment is likely that far in the money. However, if you go for example to the 1600s/160s you still get a credit. I'm not saying you must go way ITM.

  10. Also, worst case scenario with assignment, with dividends on the SPY you get 4 to 5% a year. Best case scenario, you get a very cheap call on the underlying if it rockets past 1900/190.

    #10     Jan 22, 2007