Exploiting the early exercise element of the OEX index

July 31, 2011 07:00 PM

Question: Is there a way to exploit the early exercise element of the OEX index instead of fearing it?

Answer: Yes, by exploiting the 15-minute trading window in OEX options.

Since its inception in August 1982, the S&P 100 index has been one of the most popular and liquid indexes; however, many people still consider the early exercise component a mystery. Many brokers instill the fear of God in anyone who trades anything but naked long options in the OEX index. The good news is that if you can add and subtract, then you can thrive in the OEX during the early exercise process.

When you own an OEX call (or put), you also have an embedded free call (or put) in that option. The OEX index is a cash-settled index that derives its price from the largest 100 stocks that close at 4:00 p.m. (EST). Yet, the OEX options market stays open 15 minutes longer, until the close of the S&P 500 index at 4:15 p.m. This 15 minutes opens a whole wonderful world of opportunities for an OEX option owner.

Think about it. How often does news come out right after the NYSE closes? Many companies announce their earnings right after the New York close yet before 4:15 p.m. The cash markets have stopped moving, but the option markets still are open — opportunity exists in this period. The options will continue to move off of the S&P 500 futures, yet they can be exercised at the cash price. It almost sounds illegal.

Suppose that earnings in IBM come out at 4:04 p.m. and they are horrific. In after-market-hours, the world sees that IBM is going to open $20 lower the next morning. This equates to 140 points in the Dow Jones Industrial Index (DJIA). The S&P futures will reflect the bad news and immediately trade lower by a corroborating amount. But remember the OEX cash stopped moving at 4:00 and will not reflect the new price until the next day’s open.

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About the Author

Susan Steward is chief economist at Random Walk Trading.com. Random Walk is staffed with ex-floor traders and current fund managers. Check out randomwalktrading.com free educational material.