John Arvanitis mentioned the idea of introducing a structuring desk (SD) that can offer packages of options to the IB and the HF but not pit members. The idea here would be to provide option types of various strikes - calls, puts, binaries plus combinations such as call spreads.
These would be over-the-counter trades which means they are private between the two counterparties and bilateral in nature so would not go through the exchange settlement process. Secondary pricing is provided on request by the SD in the form of a close-out price, settlement at the end of the deal would also be bilateral.
This introduces significant bilateral counterparty risk which is now non-transparent - which reflects the issues faced in 2008/9. This will require a form of waterfall that would enforce settlement with the exchange first before bilateral agreements are considered.
The only condition is that if the package is executed delta neutral (for example a 160 call might be priced at 26 points together with a short position in the traded contract at 164 at a ratio of 10:6) then the contract must settle through the exchange.
This is an interesting additional layer of complexity that has yet to be tested. The ability to price call options throughout the life of the game has yet to be developed. however I did manage to price a series of calls and puts at different strikes based on a simple average of the payoffs of a sample of 10^6 games. The results are as follows:-
Strike__ Call___ Put
100 ____65____ 1.0
110 ____55____ 1.5
120 ____46____ 2.5
130 ____38____ 4.0
140 ____30____ 6.5
150 ____23____ 9.5
160 ____18____ 14
170 ____13____ 19
180 ____9.0____ 25
190____ 6.0____ 32
200____ 3.5____ 40
210____ 2.5____ 48
220____ 1.0____ 57
More analysis on binaries and implied deltas to follow.
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