Do market makers in practice really hedge SPX and ES options in SPY or does the reverse occur often?
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Replying to @nope_its_lily
All index options are hedged in es. Carrying stock is capital inefficient, more expensive to trade, and less liquid.
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Replying to @jam_croissant @nope_its_lily
so it takes more capital for you too? i'd assumed spy shares and options had the same capital requirements for institutions
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Replying to @FREAK0NAUT @nope_its_lily
It’s not about margin requirements. Those are essentially equal. It’s about cost of carry. 2 distinctly different things.
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Replying to @jam_croissant @nope_its_lily
Ok what is responsible for the difference in cost of carry?
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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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Replying to @macrocephalopod @FREAK0NAUT and
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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Replying to @macrocephalopod @FREAK0NAUT and
"Every derivative introduces a new parameter required to price it in a model, and the derivative becomes a way to trade that parameter.” I love that.
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Replying to @Value_Quant @choffstein and
I think that is literally where I took this idea from.
11:57 AM - 9 Mar 2021
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