Investing in T-bills (Part 10)

I think the realization discovered in Part 8 will prove to be the climax of this blog mini-series. Today I am going to briefly discuss liquidity and transaction fees.

Pertaining to slippage, option liquidity would be important when looking to sell shares and trade the synthetic long stock (SLS) in addition to T-bills. I now know the potential benefit is < 0.5% per year (from Part 8), which may make doing so prohibitive. Regardless, I will proceed with the analysis.

SPY has the most liquid option market and it’s not even close. In the third-to-last paragraph of Part 5, I mention IVV and VOO as examples of S&P 500 ETFs along with SPY. At the next monthly expiration (Apr), IVV has mostly 5-point strikes, double-digit open interest at most call strikes (single-digit for most put strikes), and near-the-money (NTM) bid/ask spreads of 10-15% or more: I wouldn’t touch this with a 10-foot pole. Also for Apr, VOO has 5-point strikes, many triple-digit open interest along with some 4-digit numbers for calls and puts, and NTM bid/ask spreads close to 10%: not good. SPY has 1-point strikes for Apr, open interest of 4-5 (with the occasional 6) digits across most call/put strikes, and NTM bid/ask spreads < 1%.

Slippage is the largest of the option transaction fees—a disadvantage of trading the SLS mentioned in Part 6. Slippage will have to be paid every time SLS is rolled. This is smaller for nearer-term options (see “Total Bid/Ask Spread” column of last Table in Part 7), but nearer-term options will have to be rolled more frequently.

Other fees include:

• The CBOE “proprietary exchange fee” for products traded only on its exchange (e.g. SPX options*).
• Regulatory fees that change periodically but will be passed through to the customer by most brokerages.
• Commission rates that vary by brokerage.

Tasty Trade gives a great example of how these fees add up (reprinted here in case the page should be removed):

     > SPX TRADE EXAMPLE
     >
     > 2 short 3000-strike Call: $30.50 credits
     > 2 long 3020-strike Call: $21.50 debit
     > Total Credit Received: $9.00 per spread
     >
     > Cost to Open
     >
     > Sell to Open: -2 short 3000-strike calls
     >
     > Commission: $2 ($1/contract)
     > Clearing: $0.20 ($0.10/contract)
     > Options Regulatory Fee: $0.0581 ($0.02905/contract)
     > SEC Fee: $0.1769 ($0.0000229 x 2 x 100 x $30.50)
     > Proprietary Index Fee: $1.30 ($0.65/contract)
     > Total: $3.7132
     >
     > Buy to Open: +2 long 3020-strike call
     >
     > Commission: $2
     > Clearing $0.20
     > Options Regulatory Fee: $0.0581
     > Proprietary Index Fee: $1.30
     > Total: $3.5583
     >
     > The total cost to OPEN the spread: $7.2715
     >
     >
     > Cost to Close
     >
     > Three weeks later, position is closed for a $3.00 debit, resulting in a $6.00 profit per spread.
     >
     > 2 short 3000-strike Call: $6.00 debit
     > 2 long 3020-strike Call: $3.00 credit
     > Total Debit: $3.00 per spread ($600 total debit paid to close)
     >
     > Buy to Close: -2 short 3000-strike calls
     >
     > Commission: $0
     > Clearing: $0.20 ($0.10/contract)
     > Options Regulatory Fee: $0.0581 ( $0.02905/contract )
     > Proprietary Index Fee: $1.30 ($0.65/contract)
     > Total: $1.5583
     >
     > Sell to Close: +2 long 3020-strike call
     >
     > Commission: $0
     > Clearing $0.20
     > Options Regulatory Fee: $0.0581
     > SEC Fee: $0.0174 ($0.0000229 x 2 x 100 x $3.00)
     > Proprietary Index Fee: $1.30
     > Total: $1.5537
     >
     > The total cost to CLOSE the spread: $3.112 ($0 commission + $3.10 fees)**

Option transaction fees will further erode the < 0.5% per year edge for trading SLS. With long-term buy-and-hold share positions, minimal fees may only be incurred when opening and closing while equity commissions are often zero these days (consult your brokerage). I will continue next time with a brief mention of taxes.

* — Whether to trade SPY (third paragraph) vs. SPX options is an entirely separate debate.
       SPX is a very liquid market especially for institutional traders.
** — Fees for this trade amount to ($10.384 * 100%) / [($20 * 100 * 2) – ($900 * 2)] =
        0.47% of total capital allocation.