Swapping Jelly Rolls for TACOs

Cash-settled Index options, both listed and OTC lookalikes, have an interesting property at their expiration: their delta exposure vanishes precisely at the moment of expiry. Options traders often need to replace the delta of the expiring index options to preserve the Greek exposure of the overall portfolio. While it is possible to replace the delta – for example, by buying or selling CME E-mini S&P 500 index futures for the SPX deltas – it is not easy to achieve the exposure at a price that aligns exactly with the final settlement price of the expiring options.

Historically, traders managed this exposure by trading an options combination, or a jelly roll, a synthetic index future expiring with the option and another synthetic index future going the opposite direction but expiring at a later date. Effectively, jelly rolls are futures calendar spreads to recapture the price discontinuity inherent in the index options settlement price (either the Special Opening Quotation, or SOQ, for A.M.-settled options, or the closing index value for the P.M.-settled options). As the option and the front legs of the jelly roll expire, the deferred synthetic futures take effect to replace the vanished delta. Because the front leg of the jelly roll expires to the same SOQ as the option, the deferred synthetic futures is effectively priced versus the SOQ.

In 2015, CME introduced BTIC transactions to provide participants an alternative efficient tool to help mitigate exposure. TACO followed in 2018. With the advent of TACO+ on October 7, 2019, market participants are now able to execute days in advance a basis trade on E-mini S&P 500 futures relatives to the official opening to the S&P 500 index level for a given option expiry.

Learn more at cmegroup.com/taco

TACO transactions are similar to BTIC transactions in the E-mini S&P 500 index futures. In a TACO transaction, the E-mini S&P 500 Index futures trade will be priced at a predetermined basis to the yet to be determined opening of the cash market. Once the cash market opens, the trades in the E-mini S&P 500 futures will be priced at the SOQ plus or minus the agreed upon basis. Effectively, this is the same trade as the options jelly roll, except that it results in just one instrument instead of a combination of 4 options positions.

Following the expiration of the options in question as well as the nearby synthetic futures in the jelly roll, there are still two options legs in the jelly roll.  Capital requirement – especially for OTC look-alikes – could be higher than the TACO transaction in E-mini S&P 500 index futures. The latter would be commingled in the futures account and could potentially experience margin offsets against existing positions in the index futures. If the options trader has been using E-mini S&P 500 futures for delta hedging, the TACO transaction could offset the delta hedge for the expiring options, thus reducing the capital requirement to zero. 

Pending all regulatory approval, CME Group will launch TACO+ futures on October 7, 2019.

TACO transactions only occur on the trading day leading up to the opening index level calculation. With the advent of TACO+, participants are now able to mitigate their delta exposure days in advance of their Friday a.m. options expiration.  

By way of example, say a trader needs to purchase the cash index open on Friday, October 18. With the introduction of TACO+ trading, the trader is now able to trade the Friday open on Monday the 14. 

The TACO+ futures contract acts as a normal futures contract until Thursday a.m. This means that it has variation margin every evening until expiration. Variation margin is the difference between the daily settle of the TACO+ instrument to their basis traded. On Thursday, the TACO+ futures contract expires, and the trader now holds a TACO position until the Friday morning expiration.

TACO and TACO+ trades in E-mini S&P 500 are available for trading both electronically on CME Globex or as a block trade at a minimum threshold of 500 contracts. Please below a table depicting trading hours for TACO and TACO+.