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Monday, September 03, 2007

Scare stories - "the S&P to fall to 700"

Dan Denning, in today's Daily Reckoning Australia, considers whether it may be a good time to unload your investments, and refers to reports of large bets made that the S&P 500 may drop to 700 (currently it's around 1,474) - or possibly rise to 1,700! It's got the conspiracy theorists exercised, although experts say it's a technical matter (see The Street); but the sums involved are large. Stormy weather ahead?


AntiCitizenOne said...

It's actually just a sneaky loan.

Sackerson said...

Hello ACO: Can you clarify, please?

AntiCitizenOne said...

It's an expensive way of raising cash, for a very illiquid fund.

page 6 - WaveRunner

Please look at the following analysis of what happened in this trade IMO. This trade is MOST DEFINITELY a SPREAD TRADE IMO. Here is why. Look at the execution prices on these trades. ALL 12 legs of this trade have the EXACT SAME value when you add the strike and execution price together since all the options are DEEP in the money. For example, look at the 60 call and you will see that the execution price was 86.50. therefore the TOTAL is 86.50 + 60 = 146.50. All 12 individual legs add to 146.50. So what did the person/entity trading do? Simple IMO. They SOLD the following strikes for the following prices:

60 call 86.50
65 call 81.50
70 call 76.50
75 call 71.50
80 call 66.50
85 call 61.50

They BOUGHT the following strikes for the following prices:

90 call 56.5
91 call 55.5
92 call 54.5
93 call 53.5
94 call 52.5
95 call 51.5

So in essence, the investor has an interesting risk profile here. The investor will make money if the S&P ends between 950 and 600 on the third Friday in September and they will only LOSE money if the S&P is BELOW 530. The investor has also taken in CASH (Sold premiums for a larger amount than the ones he bought) currently that can be invested for the next 4 weeks. And they break even on the trade if the S&P stays above 950.

Anyone have any thoughts? My guess is this is a QUANT trade.


2007-08-22 22:53:19

AntiCitizenOne said...

Genesis - Page 11

There is another possibility - someone needs cash (has a MAJOR liquidity problem) and DID write them as credit spreads - with zero expectation of exercise, basically using the options MM guys as a bank.

That's wildly expensive financing due to the clearing costs BUT if you can't get access to money anywhere else, are trying to prevent an explosion in your firm, and of course YOU employ the margin clerk who would otherwise go apeshit.......

"It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions." -- Ben Bernanke
(PS: We're watching the length of your nose closely!)
2007-08-24 13:35:26

Sackerson said...

Thank you. The concern appears to start on 22 August. Reading the chatter on that thread, and assuming I understand the gist correctly, there seem to be multiple interpretations:

1. An error, spotted early and put right at considerable expense by buying one's own mistakenly-offered
contracts (but why a series of 12 errors?)

2. Brazen betting on sure financial foreknowledge, risking severe regulatory attention for dealing on insider information

3. Using the trading system to generate desperately-needed cash for a large financial organisation, even though the (even higher) dealing costs will have to be paid for later, on the settlement date (third week of September)

4. Foreknoweldge of some terrible non-financial event, such as a terrorist attack

5. a wild bet by somebody with extremely deep pockets - or facing ruin and risking all to recover his fortune

6. dirty play by "the government" to put people off betting on a crash

7. (according to Waverunner as you have quoted here) a complex bet that leave you no worse off if the market goes up, makes you money if the market drop, and only loses money if the market falls cataclysmically (below 530, i.e. a drop of about two-thirds or more) - but Genesis corrects him immediately, saying the dealing costs mean the market MUST fall below 950 for the whole bet to show a profit. Waverunner replies that maybe the dealer got a discount on the costs, which Genesis grudgingly concedes is possible, but insists the player loses unless there's a crash

Sellemsam reports that New York Stock Exchange members have been selling stock heavily since the second week in August, as they did in 2001, and interprets this as a signal that the experts are indeed expecting a big correction.

Then on 23 August, we see confused reports of even more betting on a crash, and big bets, too.

8. Dkane suggests it's a bet by someone who can influence the market, i.e. China (perhaps annoyed by being sold sub-prime loan "toxic waste" has struck these deals and will then dump the dollar. (This seems like terrible politics - but revenge can be self-destructive.)

Kochevnik says that the bet can be repeated periodically, at some costs, but still be profitable if the trader is proven right in the next few months, say.

Genesis summarises that "it is either: (1) A true bet on a crash, which loses only transaction costs if it does not occur; (2) A cute way to write a huge loan on the back of the options MMs, albeit at a rather disadvantageous interest rate. The trick here is, if someone did that, why did they need to?" And Genesis later says that it would be illegal to spend the money raised in this way, anyway - it must be held on reserve against settlement requirements.

The scale of the contracts has the traders very nervous, but Larsxe states that the size of the outstanding bets is not as great as reported earlier.

So after all the scuttlebutt, we're none the wiser, except that it seems to be an arrangement that expects a major fall on the stockmarket. The size of the bet makes everyone take it seriously.

AntiCitizenOne said...

The loan idea get the closest shave with my "Occam's razor"

Sackerson said...

It would seem cute, but Genesis points out that the trader wouldn't legally be able to use the money, and it's got to be paid back soon. So would your idea be that it's a temporary fix for some periodic accounting purpose, rather than usable cashflow?

AntiCitizenOne said...

Basically yes.