Here is what I found and it seems strange. I looked at the Dec 07 calls on SPY which are very deep in the money (SPY is now ~ $152, so the strike I was looking at was $60). I found out that Ask for such an option is even lower than BS price with Vol=0. So it seems like an obvious arbitrage, right? The BS price with Vol=0 was about $50c - $1 higher than the actual price. Why is that? Is it to compensate the transaction costs for an investor? Or was the data bogus? I used Yahoo Finance quotes.

Dividends

American excercise.Was your formula the European Black Scholes?

QuoteOriginally posted by: PaperCutAmerican excercise.Was your formula the European Black Scholes?Yes, the formula was European Black-Scholes. I don't understand what you mean though. I thought American options were always more expensive than European, so the price on an American option would allow to solve for implied volatility. In this case the ask for the call was lower than the cheepest European call (vol=0). So, what does the type of excercise has to do with it? Please, explain.Also, how can you tell if the option is European or American just by looking at the ticker? Is it possible? what kind of option is SWVLH.X?PS I was told here that the reason might be that SPY settlement price occurs at 4 eastern and the options at 4:15. could be the reason? Edit: addition to PS: I was looking at the prices after the market closed.

First of all, you can't rely on quotes from Yahoo!, especially for things that don't trade often. You will find lots of arbitrages.I suspect adannenberg is correct that you have left out dividends. If we assume this option is so deep in the money that it will be exercised with probability 1, its value is the greater of:(1) Spot value of the underlying minus present value of the strike discounted back from the day before the ex-dividend day, or(2) Spot value of the underlying minus present value of the strike discounted back from expiry minus present value of the dividend discounted back from payment day

Thanks for the comment, Aaron! Actually, adannenberg and you were right, I left out dividends and it was the source of my "arbitrage".