Theta plays: OTM vs ITM

Discussion in 'Commodity Futures' started by caroy, Jul 23, 2010.

  1. caroy


    I've been giving some thoughts lately to playing theta by buying ITM call spreads and put spreads instead of selling OTM spreads. For example with say 40 days to go you can buy a call spread in say sep beans like the 900-920 for 16 1/2 or so. As long as beans are above 920 at option expiration the spread will grow to 20. You'd have to pay exercise fees or just exit and give up a 1/2 cent to the pit on that day. It seems you could sell a deep OTM spread for around 3 1/2 cents but modeling the span it could tie up more money.

    I'm curious as to if anyone else plays the theta with deep ITM instead of OTM options? I'm sure there is something I'm missing.... so if you could point that out it would be great.
  2. samcapo


    i really doubt somebody hits a 16.5 bid or is 16.5 offered on a call spread that is that deep ITM

    I don't even know what exercise fees are but you obviously are gonna lose that at expiration from your 20c

    You also need to figure you going to pay about a half cent in fees...

    just seems like a risk ~17 to make 2 play that will probably work 9 out of 10 times
  3. caroy


    The one I'm in now SU 900-920 I entered at 13 1/2 about a week ago when SU was around 985. So they hit the bid. On this one I'm risking 13 1/2 to make 6 1/2 give up 1/2 to close it.

    I imagine a pit trader would hit it because they could turn around and sell the 920-900 put spread and have a risk free arbitrage box on that nets them profits. If the b/a on the spread is 16-17 the b/a on the 920-900 put spread would be 3-4. if they can sell both for a credit that adds to over 20 they made risk free money on the arb. Because they are paying next to nothing for commissions and member rates to clear and exercise it becomes more doable for them.
  4. You understand the box-math, yet you're asking about about the merits of the itm vs. otm vertical?

    To answer your question; you enter the spread where the strike-slope is steep... a-b > x-y in vol. Typically you will be in downside strikes in grains.
  5. caroy


    @ Atticus
    Thanks for the reply and for answering the question. I'm curious as I see these set ups in grains currently. Is this a seasonal appearance only due to the usual summer grain run and the added weather risk this year. I don't see the same set ups when I look at the softs? The ITM strikes seem to trade more at full value than the strikes in the grains.
  6. I'd have to look at the smile in the grains, as it's been too long (>10y) since I've trade grain options.
  7. A lot of what you're seeing is just due to the difference in sizes of the options prices and the resulting width of bid/ask.

    If you assume boxes are riskless trades, then the difference in strikes, minus the put spread "value", must equal the call spread "value". So selling a 20 pt call spread for 17 is the exact same thing as buying the same 20 pt put spread for 3.

    Boxes are *not* actually riskless due to early exercise and the messy mechanics of exercise if the underlying expires on/near a strike. (atticus knows this and I think caroy does too, just putting us all on the same page.)

    I'll hypothesize that in reality you'll get worse execution on the ITM side of the spreads. The MMs aren't going to screw up the pricing, and the higher legal width on the posted markets, combined with their cost of carrying the deeper strike, will swamp whatever benefit you can find span-wise.

    re: smile, skew, etc., like atticus I haven't looked at these markets in a while, but potentially huge crops and sluggish price action makes for low volatility, implied and realized. This in turn means higher skews.