Do market makers in practice really hedge SPX and ES options in SPY or does the reverse occur often?
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Ok what is responsible for the difference in cost of carry?
If I buy futures I am effectively long stock financed at wherever the lending rate clears (in practice ~LIBOR). If I buy SPY I need to get financing from my broker, who will charge me ~LIBOR + spread. The spread is responsible for the cost of carry difference.
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Every derivative introduces a new parameter required to price it in a model, and the derivative becomes a way to trade that parameter. In the case of options the parameter is implied volatility. For futures/forwards the parameter is the basis (~dividends minus financing)
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Prob silly Q, but why cant you use cash to buy SPY? Why would you need financing from broker? Very insightful. Broker spread drives cost of carry. Anything that offsets the benefit of futures? Since they have certain risk SPY itself lacks right?
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