S&P Rips The Tesla Band-Aid. What To Expect Next.

On top of everything, the index addition will be occurring on a quadruple witching expiration. This is not unusual, since SPX and another major index rebalancing typically occurs in conjunction with the quarterly expiration of index futures. Think of it this way – the December futures will expire without TSLA and will contain TSLA when March is unequivocally the front-month contract. But there are so many parts that will be moving at the very time that equity and ETF options will be expiring. Every time an underlying share crosses a strike around expiration, someone needs to re-hedge. With options open interest trending near all-time high levels, a potentially enormous amount of late hedging could be required. That Friday will see 499 names with some potential degree of selling pressure at the close and one with a potentially gigantic buy pressure. Gamma may be at a premium that afternoon, and pin risk (the risk that a short option holder may not know whether or not they will be assigned shares upon expiration) may be substantial.

Even beyond this coming monthly expiration, the addition of TSLA may have profound effects upon the volatility of SPX. (Remember that VIX is based upon SPX volatility.)It is logical to expect that the addition of a highly weighted, highly capitalized stock to an index would raise the volatility of that index going forward. A quick, back of the envelope calculation shows a rise of about ½ – 3/4% to SPX:

          SPX 66 Day Implied Volatility = 15.78

          TSLA 66 Day Implied Volatility = 62.46

          .988 * 15.78 + .012 * 62.46 = 16.34

          16.34 – 15.78 = 0.56

For the example above, I used a 66-day measurement that roughly corresponds to the number of trading days in a quarter. Different periods lead to slightly different results, but the magnitudes are similar. (To be blunt, this is an imperfect calculation. A more accurate valuation would require considering the covariance of TSLA vs. SPX and its components, but I believe that the simple calculation approximates the increase fairly).

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