On Tuesday August 23, I was forwarded the image below showing strong volume and open interest in two NDX puts that are about 30% out of the money. The image included a note asking if I had an idea what the motivation is behind the trade. The first step was to figure out which of the two contracts was sold and which was purchased along with what trades led to open interest of almost 7,000 contracts.
Source: LiveVol.com
By exploring the tape over the past few trading days, we found simultaneous trades for each contract each day going back to Monday August 15. It is not surprising to find the trader sells the NDX Oct 9200 Put and buys the NDX Oct 9175 Put as that is typical for out-of-the-money vertical spreads. Each day the volume fell between 500 and 2000 contracts and the complete size of the position is 7750 contracts. The table below shows volume by day, the average price for each option and the credit for each bull put spread, which falls between 0.21 and 0.38 depending on the day.
Sources: LiveVol.com and EQDerivatives Calculations
Using the VWAP for all trades the current position is short 7750 NDX Oct 9200 Puts and long 7750 NDX Oct 9175 Puts for an average credit of 0.26. The payoff diagram below shows the payoff at expiration based on the full position.
The closing price for NDX varied from 12881 to 13667 over the seven trading days that this position was executed. The dollar risk versus reward shows up on the payoff diagram above and the potential loss (-24.74), based on a dramatic drop in NDX, is substantial versus the reward (+0.26). However, a lot has to go wrong for this trade to be in danger.
Depending on the day, the short 9200 strike of the spread was between 28% and 33% lower than the NDX close. We gathered NDX data going back to 1985 and compared the historical price action over the same timeframe as this trade to determine how often it would make a profit. We also explored how often the short 9200 put would be in-the-money at some point over the life of the trade. This extra analysis offers an idea as to the chance that this trade would cause concern with respect to taking a loss on this position.
Sources: LiveVol.com and EQDerivatives Calculations
The distance to the 9200 put column shows the price changed needed to hit 9200 based on the NDX close each day. The final two columns show what percentage of observations would result in NDX below 9200 at expiration and how often, based on history, the 9200 price level would be exceeded during the life of the trade.
Note that about 2% of historical price action would result in some concerns with respect to this trade since the short strike would be in-the-money. Checking on the odds at settlement, this figure varies from 0.61% to 1.30%, with the most recent transactions having the highest odds of not working out, at least based on history. We will definitely be keeping an eye on the 9200 price level through the third Friday in October, but probably not as closely as the trader behind this bull put spread.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Russell Rhoads, PhD, CFA
Russell Rhoads, Phd, CFA is a highly regarded strategist, educator, and consultant – among other things he is perhaps best known as the author of Trading VIX Derivatives, the textbook in the space.
Read Russell Rhoads' Bio