Something weird happened to option prices the morning of June 4, 2010. After the pre-market release of the jobs number, the SPX e-mini futures had plummeted lower. European bourses had dropped in concert. It was going to be a bad day, likely beginning with a gap lower.
However, there was the likelihood that the gap lower would be followed by a deeper plunge. My charts were showing the possibility that the SPX could drop to about 1082, the site of a rising trendline off the May 25 low. Although I wasn't sure where the SPX would be situated at the end of the day, I thought it likely that there would be at least a bounce attempt from that trendline. But what if I could capture some of that move down to that trendline, if the SPX opened at about 1096, where I guessed it might open, and then exited at about 1085, ahead of the test of the 1082 level?
I knew that option prices would likely be inflated at the open, but if I bought a put with a delta of -0.50 or lower (so, for the less mathematically inclined, with a delta of -0.50, -0.55, -0.60, etc.), I should still be able to profit some from the trade, right? I contemplated just that move, but I just couldn't do it. Why? I couldn't do it because I knew about the dangers of trading options during amateur hour, especially right at the open.
If futures had been down about 20 points in the pre-market period, I wasn't the only one who could figure out that the SPX might drop to test that trendline in the first steep plunge of the day. Market makers could figure it out, too. Why should they sell me a put--and thereby take on long deltas in their own portfolio--when they, too, surely thought the SPX was likely to drop that low? Even if market makers weren't always involved in all options transactions in the hybrid system for the SPX options, lots of people would be clamoring for puts at the open, and increased demand increases the prices. We had two effects working in concert to inflate put prices.
I long ago learned through some negative experiences about the dangers of entering a new options trade during amateur hour. It's not that I'll never do it, but I'm extra cautious about it, and that caution stayed my hand that morning. Instead of buying a put the morning of June 4, I decided to profit from that morning's action in a different way. I decided to use it as research for this article! That saved me time looking up and researching a different topic.
The SPX opened at 1098.43. I had my brokerage page loaded with a potential trade to buy an SPX JUN 1090 put. As soon as the bell rang, I clicked the quote screen to get a quote for this option. It was bid 27.30 and ask 30.50, with a mid price of 28.90. Of course, the SPX was dropping quickly, so it was below the open, but this was within seconds of the open. I was pricing this way above that first 1081.02 SPX low made at about 9:48 EST.
As the SPX was dropping, I checked at the point at which I would have been trying to close out that trade and collect profit. The SPX had dropped so fast that it was actually a little below the 1085 level at which I would have originally planned to exit. It was at 1083.73. The bid was 25.50 and the ask, 28.00. For those who can compute mid prices in your head, you already know that this mid price was 26.75, which was 2.15 below the mid price at the open, if my quote screen was correct.
I could have actually made money by selling a put at the open and buying it back at the SPX's low of the day. Weird science, that!
But is it actually weird? No. Market makers aren't dummies. They figured out where the SPX was likely to go, and puts were priced accordingly. It's also possible, because pricing can jump around so quickly at the open, that if I'd clicked on the quotes just a second earlier or a second later, I would have gotten a completely different price for the SPX June 1090 put, one that seemed more equitable.
The lesson is obvious. If you hope to profit from a short-term move that the futures are forecasting, be aware of the danger that you won't profit as you intended. Prices tend to be . . . well, weird at the open. If, however, you want to lock in a profit on an already open trade, take advantage of that weird pricing action and throw out your order even if you think it unlikely to be filled. Sometimes that weird price action will result in a fill that locks in your profit even when it seems impossible that it would do so.