A Settlement Question

I have a question for you: Yesterday (Thursday), 6/20/13 the NDX closed at 2890, with settlement this morning on the opening prints. At 4:15pm yesterday the 2875/2865 bull put spread mid-price was $1.25. And just seven minutes before the close that spread could be sold for about $3.50 for only $6.50 risk.

Would it not have been a good idea to short the spread because one could keep the whopping $3.50 premium and then could hedge with futures if necessary to cover a gap down open? Would that not have been a good trade yesterday or other days before SPX or RUT settlement with high IV?

Hello James,

Excellent questions, but these are the situations that one has to fully understand before taking the risk, so I am glad that you asked.

There are two major points:

First, there is no need to hedge after a gap down. Once the market opens Friday morning, the value of NDX may change, but the settlement price (NDS) does not change. Therefore, there is nothing to hedge because the profit or loss has already been determined by that opening and you have no remaining risk to hedge. Of course that NDS value is not yet known, but will be calculated from the opening prices of each stock in the index, and announced later in the day.

Note that NDX did open lower on settlement Friday – probably because (this is merely an educated guess) that one of the major components issued bad news just after the market closed on Jun 20. The ‘whopping premium’ did not appear out of nowhere as a gift to premium sellers. Something had to cause that change in the option prices.
In other words, whatever it was that happened was expected to be bearish for NDX the following morning and the puts were bid higher (and I assume that the calls were bid lower).

As it turns out, NDS for this cycle is 2957.95*** and anyone who sold the spread that you mentioned lost the maximum. I hope this is just a theoretically question and that you did not sell any 2765/2775 spreads.

    ***I don’t know how this is possible, but when double-checking that NDS value, I discover that it is now (Jun 23, 1pm CT) listed as 2961.91, making the put spread worth $8.09. Saturday, the settlement price was much higher, indicating that the put spread expired worthless. The fact that the CBOE cannot list a final, unchangeable NDS (that’s settlement for NDX) price is very unsettling.

The true bottom line is that the sudden (after the market closed) surge in the value of such spreads should be a warning that something happened. I am not suggesting that you never make the trade that you suggested, but it is not a good idea to make it without knowing exactly what happened to cause that bearishness.


In a further discussion I learned that James was considering adjusting the position, using futures, prior to the market’s opening on Monday. The problem with that idea is that by the time the futures markets begin trading, any anticipated decline in NDX has already been priced into the futures, and it is too late to hedge the position.

However, I have an alternative to suggest:

    Let’s assume that you wanted to sell 30 put spreads (i.e., trading the bullish put spread) and hedge with an appropriate quantity of futures contracts. How about avoiding the hedge (eliminating upside risk) and selling a far smaller quantity (perhaps 5) of put spreads? That gives you a chance to earn a decent profit, but without being concerned with hedging. That may not work for you, but it is an idea to consider.

One Response to A Settlement Question

  1. Ben 07/10/2013 at 6:30 PM #

    Hi Mark,

    I sent you a comment back in May introducing myself and giving a little background info. Well I have been true to my word and actively traded iron condors since then. I have been trying fair high probability condors (4:1 risk to reward) on NDX, SPY, QQQ, VOD & AMZN, with expiry dates ranging from July to October.

    I thought things had been going reasonably well but struggle to reconcile the ‘performance’ summary on the CBOE paper trading account to my account value. I spent the evening exporting all of this data to excel and preparing my own spreadsheet and it turns out I have made a small loss of around $1,000 so far. This isn’t a huge surprise as i have had to roll a few condors and experimented with kite spreads and call spreads as adjustments when the underlyings have started to be approached. In particular I have had quite a ride with AMZN, i’ve rolled the call spreads twice. Today I have closed my NDX and QQQ (yet to be filled) positions as NDX is a July expiry and though QQQ is an august expiry gamma is getting too high and I had made around 70% of the possible profit. Why be greedy when gamma could blow it all away quickly.

    I have rambled on long enough, consider up to this point to be just background information please and I will get on to my questions now.

    1) I think I have spent a lot on commissions and fees (around $2,000 so far) and for my SPY and QQQ. It’s cost me about 10% of the opening credit to open the positions. I understand that this is due to the high number of contracts traded, 100 and 200 respectively, coupled with the relative ‘cheapness’ of the options sold, $19 per SPY contract and $20 per QQQ contract. The longs and shorts of both if not all of my positions are one strike apart (SPY Aug puts 146/147 calls 172/173, QQQ Aug puts 64/65 calls 78/79). Is there anything I can do to reduce the relative value of commissions and fees?

    I know that I could increase the distance between my longs and shorts to say 2 strikes but this is not wise as its effectively selling all the spreads inbetween the long and shorts, i.e. id be selling the 78/79 call spread and the 79/80 spread if i widened my QQQ calls to 78/80 in future condors. For this reason it doesnt appeal as a solution.

    Alternatively I could be open lower probability (therefore higher priced) positions, this would reduce the number of contracts I trade and commissions would reduce relatively. I don’t like this solution much either as am already making enough adjustments as strikes are coming under threat with my high probability approach. I may experiment with this in the future but for now im happy with the higher probability/lower reward condors.

    Perhaps there are other indices I could trade which are more expensive?

    You may well point out that i’m not trading any RUT options despite these being a favourite of yours. This leads onto my next question, which may actually be better directed straight to the CBOE website…

    2) I can find option quotes for RUT on the CBOE paper trading account but it doesn’t seem to work. The website does not give a quote for RUT itself and as a result the platform does not give any probabilities, R/R or greeks for any RUT options. In fact im yet to even have a fill on any RUT orders. This is surprising as I though RUT was solely listed on the CBOE exchange. I could open a paper trading account at another website but im loathed to lose all of the data and history i’ve built up so far. What do you suggest I do here please?

    3) I’ve experimented with single equity options (such as AMZN and VOD) as per my introduction. Though the premiums collected are juicy they are certainly the condors that have required the most attention and adjusting. This is probably the reason premiums are so good, single equities are more volatile, even the mega-caps. Are there any European style, cash settled, liquid ETFs which i can trade options on or are all ETFs equity settled American style by definition?

    4) The least important of all my questions and one you can feel free to avoid completely but I thought i’d ask anyway. Much further down the line, if I can prove myself to be profitable and a good risk manager I may start trading small with real money. I’m a UK citizen and resident but the American options environment is just better. It’s more liquid, there is greater choice of underlyings and importantly much more competitive brokers. Do you know if a UK citizen can open an account with an American broker and trade your options?

    This post has gone on far too long and if you have made it this far I thank you. Any input you can give which you feel would be uesful will be greatly appreciated. If you have any questions for me or need any further information please let me know. I could provide the spreadsheet if wanted.

    Thanks again


    Complete reply in blog post dated July 11, 2013