# American Style Index Options - Risk of Early Exercise



## Fox (6 March 2010)

I had my first look at SPY options this morning and was astounded by the huge volumes and super tight spreads. I got all excited.:bananasmi Later on, I discovered that the options were American style options. Excitement turn to confusion.  I had always assumed that all index options were European.

I know that there will be circumstances when American style options will be exercised early. For example, equity call options deep ITM my be exercised just before the underlying stock goes ex-dividend. However, I'm not too familiar with reasons for exercising index options early.

Can I please get help on these questions? For American style index options:
1. Are there circumstances where the option buyer may wish to exercise early?
2. Are the occurrences of early expiries of rare? 
3. Has anyone personally been exercised early?
4. Would income traders be put off by American style index options?


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## cutz (6 March 2010)

Hi Fox,

I wouldn't really consider SPY options to be index options (it's actually a S&P500 EFT), better described as a stock, they pay dividends so early assignment is a real possibility especially if short on a DITM call.

I also think margins on SPY are higher than index options, WayneL could perhaps shed some light on these issues as I vaguely recall he has traded them.

I briefly dabbled with them ages ago but the trading hours were not suitable for my situation.


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## wayneL (6 March 2010)

Fox,

Important thing to note - SPY is not an index, SPY is an "index tracking" ETF. It is an asset, AKA a stock.

Ergo, SPY options are not index options. They are physically settled, not cash settled like index options. That's why they are A style rather than E style.

Early exercise is likely in all the same circumstances as stock options.

Another thing to keep in mind is that, because SPY is an asset, the options have cost of carry priced in, so that slightly affects delta as well.

Cheers


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## Fox (6 March 2010)

Thanks Cutz and Wayne. SPY being an ETF (paying dividends) makes the picture a lot clearer in my head. 

I just subscribed to US data recently on IB and suddenly I am presented with such a large array of instruments to look at. Up to now, I only had ASX data and have been used to just looking at XJO. I feel like a country bumpkin :sheep: visiting the bright lights of New York for the first time. I'm in awe of such huge volumes and super tight spreads  of the SPY.

I'll stay clear of ETF options for now and stick to index options. Thanks again, guys.


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## cutz (6 March 2010)

Hi Fox,

Check out XEO for a european style US traded option (S&P100 index).


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## Fox (11 March 2010)

Wayne/Cutz,

I notice that Index futures options like ES and SPI are American style. Futures, unlike ETFs, do not pay dividends. So there must be other reasons why the buyer of a futures option may wish to exercise early.

Can I find out if it is *rare *that futures options are exercised early? How does a seller of futures options, *avoid *being exercised early?

Thanks guys.


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## wayneL (11 March 2010)

Fox said:


> Wayne/Cutz,
> 
> I notice that Index futures options like ES and SPI are American style. Futures, unlike ETFs, do not pay dividends. So there must be other reasons why the buyer of a futures option may wish to exercise early.
> 
> ...




If you assigned, it is most likely that the option was deeeeeeeeeeeeeeeep ITM with a delta of close to (-)1. You are assigned the future, also with a delta of (-)1.

With the SPAN margin rules for futures, this is no great disaster in most cases as your margin will not likely vary a whole bunch... depending on the total position of course.

With futures I like to avoid ITM options anyway, in favour of the corresponding synthetic. Apart from anything else, the spread, even with two positions, will be tighter than the ITMs.

This is a significant difference with futures options, i.e. always look at the synthetic for a better deal, spread-wise and margin-wise.

Example - If the index is @ 1000, the long future with a 950 put will be better than a 950 call. This is the opposite to the general principle with stocks, where the 950 call would be a better idea.


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## cutz (11 March 2010)

Fox said:


> Wayne/Cutz,
> 
> I notice that Index futures options like ES and SPI are American style. Futures, unlike ETFs, do not pay dividends. So there must be other reasons why the buyer of a futures option may wish to exercise early.
> 
> ...




Hi Fox,

Can't really say why a futures options would be exercised early from a retail point of view.

Arbitrage operations on the other hand would do so if prices become out of whack so i guess you'll never see a deep in the money trading below intrinsic like I seen on XJO's ( vague recollections, please don't ask for exact details  ). 

That's all I can tell you, hopefully WayneL could shed some more light.


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## Fox (11 March 2010)

Thanks Wayne and Cutz. Looks like futures options is a different kettle of fish to index and equity options. 

I was initially under the impression that trading index options vs. trading index futures options were similar. This was probably due to XJO options being hedged using SPI futures.

I was attracted to ES initially because of the 24 hour trading. However, the nuances of futures options warrants further learning for the novice. Looks like I will need to learn and read  more about futures and futures options, given what I learnt today.


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