Minyan Mailbag - Pricing
My head hurts!
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
Why are the equity April S&P 1240 call quotes on the CBOE at $5.70 (bid at $6.90) and the e-mini futures options on globex, ES 1240 calls are at $7.00 (bid at 7.75)? And, why couldn't I buy 1 at $6.90, sell 2 at $7.00 and hold till expiration and pocket $10.00?
First the multiplier on the SPX cash is 100 and the equivalent then for the e-mini options on futures would be only 50. If we look at it this way, the amount collected is very small at (-$6.90 x 100) + ($7.00 x 2 x 50) = $10 per option.
So let's look at it by figuring out what it should be.
The SPX cash option on the CBOE is European exercise while the e-mini is American. An American option has a higher value (which grows as you get itm)" target=_blank>in the money) because you can exercise it anytime.
Further, the e-mini is exercised into a June future contract. This gives it a higher valuation as well.
If in April the index is below 1240, both options will expire worthless and you will collect the small $10 per contract.
But if both options go above 1240 by April, you're long SPX cash option will expire into cash and you will receive the intrinsic amount. But you will be left over with nothing as a hedge. The e-mini short call will turn into a short June futures contract. You will be left naked short futures unless you unwind or re-hedge.
To calculate the value of the e-mini you have to figure out the value of a theoretical futures contract between April and June (none exists). This value is $2.50 (the cash carry value of the index less dividends paid). So if the cash value of the index is 1210, to value the e-mini you add this amount to the index level to get 1212.50. You then take the same implied volatility that the SPX cash option is trading at (11.3%) and value the option using a 1212.5 index level and an American exercise.
In addition, as you approach 1240 in April, there is a chance that the SPX cash would go out worthless while the e-mini would be exercised and have value.
The theoretical value of the e-mini option is around $.60 higher than that of the SPX cash option.
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