When short dated options were introduced on stocks and ETFs I made an assumption. We all know assumptions may be wrong, and that is the case here. I thought the major use of short dated options would be to take advantage of at the money time decay. I was actually half wrong as we do see option short sellers come into the market place fairly frequently when expiration is approaching.
The use I did not foresee involves using a short dated options as a substitute for a futures trade. A few years ago I noticed a deep in the money RUT call purchase for an option that had three days remaining to expiration. I conferred with the other instructors at The Options Institute and we decided to take a look at the cost of this option versus the margin required for a Russell 2000 futures contract. My recollection was that it was a deep in the money RUT Call option that had about 1 point of time value and cost 40.00 or $4000 in real money. At the time I believe the Russell 2000 futures margin was closer to $6000 which gave a trader basically the same exposure to the Russell 2000, but at a higher cost.
Fast forward to recent history. We now have S&P 500 Index (SPX) options expiring two times a week, typically Wednesday and Friday. Since the market was under pressure for the first half of this week, I decided to compare purchasing a deep in the money SPX Put versus shorting an S&P 500 E-Mini futures contract.
From Friday June 10th to Wednesday June 13th the S&P 500 dropped from 2096.07 to 2071.50 or 25.57 points. If you had seen that coming you may have considered selling short a September E-mini S&P 500 futures contract. The S&P 500 futures contract closed on that Friday at 2087.25. If held to the close on Wednesday, the result would be a profit of 27.50 points as the contract settled that day at 2059.75. In dollar terms this is a profit of $1375 as the dollar multiplier for these contracts is $50 a point. I checked the CME website and the maintenance margin for this trade is $4200. Let’s think of that as the cost of the trade as well, since I’m going to use this amount again in the next paragraph.
So what about options? Since this is the CBOE Blog site you knew this was coming. Late Friday last week, with the same bearish outlook, you may have chosen to purchase a SPX Jun 15th 2135 Put for 40.50 or a cost of $4050. This is slightly less than the margin number for the futures contract. This option settled on the close this past Wednesday and was 63.50 points in the money for a profit of 23.00 points. That’s a little less than the profit for the futures contract, but that is in terms of index points. The multiplier for the SPX put is $100 so that 23.00 profit is worth $2300, substantially higher than the profit for selling short futures. It appears the option trade gives you a bit more bang for the buck.