Option Price Anomalies
Quick question, can a put option ever be more expensive than a put option with a higher strike price? Ie Can a put with Strike=720 ever be more expensive than a put with Strike=1000 (for the same underlying, maturity etc)?
I am trying to figure out whether implied vols can spike for on but not the other.
No way
if the 720 put was more expensive than the 1000 put then you could buy the 1000/720 putspread and get paid to hold it.
It shouldn't. Some of the smile models (take SABR) can violate this principal at very low delta strikes, so modifications and improvements have generally made more parsimonious models. Now, is that to say it can't happen? Not at all, I've seen (and traded on... natch) much more obvious arbs in the market.
More obvious than putting on spreads with strictly non negative payoffs for credit? What does that even mean?
more obvious can be something as simple as: 1 month EURUSD ATM strikes where market maker #1 is: 10.5/10.75 market maker # 2 is: 10.1/10.35
yeah... that's more obvious than hunting for individual strike mismatches, especially seeing as 1m EURUSD atms are one of the most liquid contracts in the derivatives space.
Maybe if you call up some market makers and one of their prices is just out of whack. Nothing like this trade (or the options spread from above) is gonna sit around on the screens without anyone hitting it out, especially since for orders on exchanges crossed markets = trade goes up, not an arb opportunity.. Or maybe you can build the infrastructure to be the fastest of all participants so you can jump on no brainer trades before anyone else?
I could be wrong, but if by "anomaly" the OP means obvious arbs, they're either going to be hard to find, or if a lot of people can find it it's going to be hard to be first. If the OP means any number of much more subtle situations that are actually tricky to understand.. That's a different set of challenges.
To be clear, I don't mean that any of these ideas can't be useful motivations for profitable strategies. But it takes work to be competitive, and there aren't a lot of opportunities to walk around saying "takem! sold!" and walk away with riskless cash.
juked07, i was strictly responding to your comment on Rivelli's post. obvious arbs in our market (OTC FX Options) are never on the screen, they always occur when you call up some retarded bank like HSBC on Reuters and they have no idea where the market really is.
But yes OP, u said u were trying to find out if implied vols can spike for one option and not the other? it happens all the time (but never to the extreme that u described, i.e. such that the low strike put is worth more in premium than the higher strike)
e.g. 10am ATM vol: 10% 25 delta RR: 2% (assume flies are 0%)
then your 25 delta put has a vol of 11% and ur 50D put has a vol of 10%
1pm ATM vol: 10% (unchanged) 25 delta RR: 4% (assume flies are still 0%)
now your 25 delta put has a vol of 12% and ur 50D put still has a vol of 10%.
(note: one option vol changed, the other remained constant)
You laugh like it couldn't happen but there are some market players that will just go to a broker and tell them to sell/buy 1m AUDUSD immediately or something, they give em meanwhile there is a better bid on the screens out there. So if you're the guy that got given, you can immediately whack the screen. Things like this don't seem like they should happen, but they do. I'm not saying it happens everyday or every week even, but it doesn't have to happen frequently to be considered an arb!
And no comment on your call-out comment FXTrader :-) Arbs definitely arise in that situation, but it's sort of poor form to do so I'd say.
Oh and like FXTrader said, FX isn't exchange based so different brokers have screens but they are not integrated. When you were talking about earning to do a put spread I assumed you were talking about working the legs in different shops... I don't see how anyone could possibly screw it up as a spread unless they only look at vols and not pips/price and their model is fked.
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