Thursday, December 3, 2015

AM and PM settlement explanations

I have been reading about SPX and other indexes like crazy. The more I read the more fascinating they are.
The whole dynamic is very different than equity plays.
Firstly SPX is determinant on its constituents, which vary from a smaller Citrix to a colossal Nike or Alphabet.
These representations are weighted so a component move moves according to its size and doesn't cause imbalance to the whole index.

Therefore it is quite safe to say that it is more balanced.

The key risk in my opinion is the settlement price. I will need to collate some historic data but there are numerous instances when the index appeared safely OTM on Thursday before expiration only to go deep in the money at settlement time.
I believe one crushing instance was in 2009 when it finished 15$ OTM on Thursday only to settle at 9$ ITM. 
Weekly SPX options (SPXW) are AM settled, meaning CBOE takes the opening price of the option Sell (bid) price for all the constituents in determining the final SPX settlement price.
Update : SPXW is in fact PM settled as per the latest CBOE info.
Furthermore it can be traded on the very last day as well right upto expiry, this is awesome news!
I will test it next week on a long position and confirm in another post.
From CBOE website.

DescriptionUnderlying Index / Options ChainOptions Root Ticker SymbolAM or PM SettlementNotional Size (approx. value with SPX at 2000)Exercise-StyleSettlement Type
SPX (Traditional, AM-settled on 3rd Fridays)SPXSPXAM-settled$200,000EuropeanCash
SPX Weeklys (PM-settled at ends of weeks)SPXSPXWPM-settled$200,000EuropeanCash
SPX End-of-Month (PM-settled at ends of months)SPXSPXWPM-settled$200,000EuropeanCash
SPXPM (PM-settled on 3rd Fridays)SPXPMSPXPMPM-settled$200,000EuropeanCash
Mini-SPX Index Options (3rd Fridays and Weeklys)XSPXSPPM-settled$20,000EuropeanCash
SPDR ETF Options (3rd Fridays, Weeklys and Quarterlys)SPYSPYPM-settled$20,000AmericanPhysical ETF

On illiquid options that means they have to wait until such a trade takes place to book the price, it could take all morning, or perhaps not at all.

So for e.g. , Apple and AirLiquide are part of the SPX, you have a 2000P contract on SPX. Apple's options are traded very quickly and CBOE books the trade early on at around 8:45 am, whereas Air Liquid's open interest is weak and there's no movement till 11:45 am, that's when the CBOE is able to close out the settlement price of the SPX.

Likewise PM settled is the last bid price before close.

I am really fascinated by cash settled European style indexes, as long as you can keep your greed to a reasonable amount, invest copious amounts of intellectual energy in determining accurate strikes you can comfortably make a lot of money.

50 equidistant contracts 2 weeks out easily pays 1.55$ per and yields 7750$ on a margin hold of 25000$, that's 31% return on margin. (Assuming a wing of 5$.)
Pretty good deal anyway you look at it.