Burnt by the RUT

Written on August 2, 2007 by OptionsRopeaDope

I’ll count this as a lesson learned.

If you trade any of the cash settled index options (RUT, SPX, NDX, etc) a little known fact is that the settlement price at expiration is not the value of the index at all. That’s what happened this past Friday. The RUT opened in the high 820s, and closed there at the end of the day. The settlement price for options? 835.45.

How did this happen? Well, if you look at the official specs for these options you’ll spot how settlement happens. For example, here is how the RUT options are settled:

Exercise will result in delivery of cash on the business day following expiration. The exercise settlement value (RLS - Russell 2000, RUC - Russell 2000 Growth, RUU - Russell 2000 Value) is calculated using the first (opening) reported sales price in the primary market of each component security on the last business day (usually a Friday) before the expiration date. The exercise-settlement amount is equal to the difference between the exercise-settlement value and the exercise price of the option, multiplied by $100.  

Get that? So, the “RLS” may have nothing to do with the the Russell index at all. Looks like most of the companies in the RUT opened near their high, and at different times, so the settlement price was higher than the Russell 2000 was all day. It gapped up over 3% from the day before! This isn’t the first time this happened either, it happened in April.

The moral of the story is, be careful.  A good strategy is to buy back all short options before the expiration date, so you don’t get burnt.

Here’s some of the other indexes and what their “true” value is when it comes option expiration time:

  • RUT - RLS
  • SPX - SET
  • NDX - NDS

 

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