2
$\begingroup$

There's a relatively new product in the market / on the Nasdaq called Alpha Indexes. It lets one own a company -- e.g. Apple, GE, Google, etc -- as the difference between how that company does (the "target"), and a benchmark (e.g. SPY). That seems like a "stock analyst's dream", being able to say they believe company XYZ will grow their earnings and do better than the market by X%, rather than assigning a future price to something that could be greatly affected by other factors (e.g. Euro debt crisis or whatever next crisis), which frankly, seems highly incestuous: having to pick the price of a particular instrument, that is affected greatly by other instruments in ways it should not be (vs. investing on relative performance).

The question I have is, how closely can this return be done today with options. What are the parallels, and how close/far off are they? Perhaps beyond company XYZ vs SPY, what if someone just wants to own gold against copper, or Apple against Microsoft, etc. That seems like just substituting another benchmark in.

Improve this question
$\endgroup$
1
  • $\begingroup$ There is an error in your question. The product they are selling is an option on the index, not the index itself. See my answer. $\endgroup$ – Tal Fishman Dec 1 '11 at 22:53
1
$\begingroup$

My understanding is that this is a completely new product which is not perfectly statically replicable given current instruments. The product, which your explanation does not make clear, is an option on an index, where the index value is close to (but not exactly, due to dividends) the total return from a long-short position in the two underlyings. It is not replicable with existing options because, for example, the deltas of options on the underlyings would change if the two underlyings moved in the same direction in lock-step, but the delta of this new option would not (the index value would remain at 100).

To use your example, simulating AVSPY (AAPL vs. SPY) is very easy using equal dollar positions long AAPL and short SPY. However, that is not the point. AVSPY is just an index underlying for a new options chain. One could, of course, replicate this option dynamically by trading the AAPL-SPY long-short pair, but that is subject to all the usual caveats of dynamic replication.

Improve this answer
$\endgroup$
4
  • $\begingroup$ Thanks Tal. There is both the index, e.g. AVSPY (NASDAQ OMX Alpha AAPL vs. SPY Index), and then separately options on that index (which I have yet to digest, if their equations, etc are the same; please comment if you know). Doing the long-short pair may cause one to have to pay fairly significant interest rates charges on the short, which changes the return substantially (e.g. I guess your comment on dynamic replication"?) $\endgroup$ – Ray Dec 2 '11 at 1:53
  • $\begingroup$ The index is just a construct whose sole purpose is to serve as the underlier for the options. The index cannot be traded directly. $\endgroup$ – Tal Fishman Dec 2 '11 at 2:59
  • $\begingroup$ Geeze, missed that. $\endgroup$ – Ray Dec 2 '11 at 7:30
  • $\begingroup$ They have a $1 option, to approximate the buying/selling the index. $\endgroup$ – Ray Dec 5 '11 at 21:56
2
$\begingroup$

These Alpha Indexes are a bet on the excess returns of the target instrument. Options are, ultimately, a bet on the volatility of the underlying. The two are not related. If you wanted to replicate an Alpha Index of gold against copper, just buy gold and short copper (usually through the futures market). Again, this has nothing to do with options.

Improve this answer
$\endgroup$
8
  • $\begingroup$ Thanks. So to simulate AVSPY (Apple vs SPY), one could simply buy Apple, and short SPY? Would one need to match up the amounts bought / sold to 1 to 1, to do the equivalent? Secondly, why even have Alpha Indexes? Is it for the options capability, or ? $\endgroup$ – Ray Dec 1 '11 at 22:04
  • $\begingroup$ @Ray Match the dollar amounts. $\endgroup$ – chrisaycock Dec 1 '11 at 22:05
  • $\begingroup$ Thanks Chris, sorry, edited my comment. Why even have Alpha Indexes then? Is it the options capability on them, or do they behave differently in some way? Thanks. $\endgroup$ – Ray Dec 1 '11 at 22:09
  • $\begingroup$ E.g. perhaps use less of one's cash balance available for investment (generally speaking)? $\endgroup$ – Ray Dec 1 '11 at 22:10
  • $\begingroup$ @Ray Beats me. PHLX's FAQ doesn't really address any benefit that isn't already available through pairs trading. $\endgroup$ – chrisaycock Dec 1 '11 at 22:17

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.