Dec 08 has more time than dec 07. (And then there is synthetic time as atticus already mentioned). If you look at an option chain you'll see that the more time to expiry an otm option has the higher its delta. For example, the otm june 60 strike has a lower delta than the nov 60 strike. Conversely the itm option has a progressively lower delta as you go out in time. Natenberg explains it in more detail. db
daddy'sboy I was confused on the time increase issue on an open position. I think both atticus and TimeCorrosion explained how time can increase on open positions. I still don't completely understand it though.
An open position obviously doesn't 'increase in time' but an increase in volatility has a similar effect on the position as if there were more time to expiry. For example if you're long 100 sbux june 30 calls then you know you have x days to expiry and your premium is y. If iv then suddenly goes up, your calls will increase in value (y goes up). This is similar to being long those same calls but having more time to expiry, iow your calls are more valuable the more time is left in them. As I said Natenberg explains it pretty well and has some good graphs. db
Forward is nowhere near that, at least as a value to be calculated. It is Forward = cash * (e ^ ((r - d) *t)) where r = risk free rate, d = future "dividends" (cashflows), t is the time to expiration, and e is the base of the natural logarithm. nitro
That is incorrect. The forward is the correct way to asses future values, critically so if you are hedging (e.g., an option) with the front month future, and need to roll the contract forward as the front month futures expire (i.e., the option expires after the future does). The only future one should use as the forward is the front month future if all underlyings you are valueing expire before that future, because then there is nothing to roll for that particular underlying. nitro
Isn't that what I said (excepting continuous compounding) ? If you really want to split hairs then how does your formula account for the interest received on the dividend stream ?
Exactly. Logically then, the futures value (as seen in the market place) will be the forward value of the underlying. Not so. If the futures value differed (significantly) from the forward value then there would be an arb to be had by buying one and selling the other. This principle applies to all futures expiry months, not just front month.
Right, but the complication is that what you use depends on what the underlying expires into. For example, SPX options expires into cash, so a forward is the correct valuation there. However, options on ES expire into futures, so the forward isn't exactly right since you get futures instead of cash if the option is exercised, and futures have time value. Therefore, what you want in the ES options case is the implied synthetic future for the given expiry (I am just using options as the "cash" in this case) that expire after the current from month. The idea in their computation is very similar, but the forward and the synthetic implied future will have drastic different values for the reason given. Read the article linked in the second post here (scroll the article all the way to the top): http://www.synctrading.com/phpbb/viewtopic.php?t=14 nitro
I hadnât considered the case where options settle into futures contracts, and concede your point regarding the forward value of those options. However, the original Q related to DJX options, which (I assume) settle to cash, and to which my answer(s) relate. Agreed. You could of course also take the implied synthetic future value for cash / stock settled options for months where no actual futures exist. Between us I think we have managed to complicate what was a fairly straight forward initial question. Thanks for the link â some bedtime reading