In an earlier post we looked at how intraday securities lending data will affect the idea of transparency in U.S. regulation. In this post we look at how the dissemination of intraday data will have an impact on other markets, in particular on equity-linked options.
The idea of intraday securities lending data is that market participants update the current rates they receive multiple times a day. The refresh is not instantaneous although it is frequent enough that participants can see updates and rerate their loans at frequent intervals during the trading day if they are so inclined. The service is now being offered by SunGard with other firms likely to follow.
For options traders whose pricing is based off the Black-Scholes formula, the rates of hard to borrow stocks matter greatly. For the mathematically inclined, the actual Black-Scholes formula for a European call option is:
As it turns out, all we really care about in these equations is the r, which is defined as the risk-free rate. For a general collateral stock, the risk-free rate is the Fed Funds rate. But for hard to borrow stocks, r = the actual rebate rate of the security in question. R gets plugged in by options market makers and other smart people based on their own cost of financing. It is important to also note that the constraints surrounding the lender side of securities lending data and benchmarking do not apply here: for options traders, a rate is a rate is a rate.
If an options clearing firm sets one rate per day based on their last night’s financing cost and that stays stable, then there is no trouble. But what happens when the rate changes a few times a day and the options market maker can see that reflected in the data when they go to price their book (presuming an electronic rate data feed from the clearing agent)? If some form of data is flowing through from the intraday securities lending feed to the options market maker, then the market maker will price their bids and offers accordingly. All of this will happen in real time. If markets weren’t moving fast enough before, they sure will now.
Getting a forward look on what funding rates will look like tomorrow also has ramifications for options pricing today. If an options trader can see a funding rate getting tougher, she will know to calculate her spread accordingly. One options firm with this information would have a significant information advantage over its competitors. The only thing worse for a trader than missing a deal with a client due to non-competitive pricing is to actually execute when it turns out it was priced incorrectly.
The introduction of intraday securities lending data may seem like an isolated event but really has ramifications for other parts of financial markets. Likewise, securities lending itself is integral to the workings of other markets and without it, liquidity would slow and certain operations would prove cost prohibitive. For options traders, intraday securities lending data promises to add another level of complexity to their pricing activity.