Thursday, September 13th, 2007
The $900 Million ‘Mystery Trade’
By Keith Fitz-Gerald
Contributing Editor
I wrote to you recently about an unusual series of S&P 500 Index (SPY) options trades worth $900 million or more - give or take a few zeros.
In fact, as it turned out, we were one of the first - if not the actual first - mainstream news organizations to write about these trades, which were being talked about at length in the global community of professional traders that I’m part of [More on our "scoop" momentarily].
Not only were the trades unusually large, but their placement so close to the September expiration and the fact that they were so deep in the money made them a complete enigma. Add in the fact that none of the parties to the trade were talking (a puzzler, too, as the trading community typically loves to talk) and you’ll understand why this story quickly rivaled the alleged 1947 UFO crash in Roswell as a topic of interest and a focus of conspiracy theorizing.
According to my research, anonymous parties agreed to buy and sell 120,000 September (SPY) call options using deep-in the-money strikes ranging from 60 to 95. Now, if you’re not options savvy, don’t worry. SPY - also referred to as a “Spider” in trader parlance - is an exchange-traded fund (ETF) that mimics the performance of the stock market’s closely watched Standard & Poor’s 500 Index (INX). These strike prices equate to a SPY trading between 600 and 950, or roughly 35.81% to 59.46% below where the security was trading when I broke the news of the trade back in August.
As a longtime professional trader, my own take at the time was significantly less ominous than some of those posted on the message boards, where some had dubbed these as the ‘Doomsday Plays’ or the ‘Bin Laden trades.’ Others questioned how other professional traders and I could even consider trading this “trade.” And when other mainstream media organizations followed our lead and began reporting the story, they were unevenly divided between two camps: Most were in the first group, theorizing that there had to be a logical explanation for the trades, while in the second - the minority - reporters theorize there must be a more-sinister motivation.
As it turns out, my initial impression was much closer to the truth than even I realized. As a result, I’m relaxed and in an even-less conspiratorial mood now.
Let me explain ;
What nobody could figure out about this trade was the “why” and, in fact, they still can’t nail it down with any degree of certainty because there are just too many possibilities.
One scenario, however, is standing out as being more reasonable and more likely than all the others. And we have a bit of insight to base some of our more-rational theorizing on, and that’s only because someone finally talked. That “someone” was Dan Perper, a partner at options-market-maker Peak6.
Perper was widely quoted recently as saying that the trades are part of a “box-spread trade.” I wasn’t personally able to reach him over the past week, so I cannot confirm this firsthand. But he’s widely respected - as is Peak6 - and the comments were broadly disseminated, so I have no reason to doubt what’s been reported.
As for the “box-spread trade,” and what it is supposed to accomplish, let me just say that it is a highly specialized transaction that professional traders or sophisticated institutional investors use on occasion to “box” in the market and guarantee profits, risk or, as may be the case with this trade, financing.
Without boring you with the details, here’s what you need to know about how this type of trade works. Basically, the counterparties, in this case a buyer and a seller, agree to a trade at a price that essentially splits the difference between current interest rates or prices. The price the trade takes place at is really is a moot point.
What’s important to understand is that the seller benefits because they essentially get to borrow the money from the buyer at a slight discount to prevailing market rates, while the buyer is able to keep his money moving in what is essentially a cut-rate loan at a time when he probably can’t lend it to others at all and risks it standing still - the kiss of death for a financial firm that depends on its liquidity for daily operations.
So what does this tell us in light of the fact that somebody placed bets now covering over 132,000 September options, up from the initial 100,000 on August 16th?
In a nutshell, if this monster trade actually is a box trade, it suggests to me that an unknown major player is hurting for cash and couldn’t obtain it any other way.
It also suggests, as I have said for the past few weeks, that the subprime slime is not yet out of the global financial system.
The only question that truly remains in my mind - again, assuming that this is a box trade - is who’s hurting so much that they needed more than $900 million badly enough and immediately enough to utilize such a trade structure. And, in a related question - so there are two actually - is who couldn’t get traditional financing even with the Fed offering liquidity as a last resort?
I bet we’ll find out in the next few weeks when the several of the bigger financial houses report earnings and a number of hedge funds make decisions on redemption requests.
Oh, and by the way, even if this trade does wind up being a box, I still find it too coincidental that it is slated to wind up this month near the anniversary of 9/11.
I guess there is a little conspiracy theorist in me after all;
[P.S. As I mentioned earlier, Money Morning scooped every mainstream news source on this “Mystery Trade” story. When you look at the related links, you’ll see that our original report appeared first thing in the morning on Wed., Aug. 29. But as you’ll see from everything we’ve posted here, the other news organizations didn’t start running their stories until Wed., Aug. 30. I mention that only to underscore that, as a Money Morning subscriber, you can be assured of getting news and investment ideas before everyone else.
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Related News and Story Links:
- Money Morning News Analysis:
This $900 Million Bet Has Global Traders Talking. - The Street.com TV Interview Video Clip:
‘Bin Laden’ Trades Stir Terrorism Fears. - TheStreet.com:
Dispelling the ‘Bin Laden’ Options Trades. - TheStreet.com, et al:
Bin Laden Options Trades Have Wall Street Whispering.
Jim Rogers: China’s Expansion Depends on Water
Oil isn’t China’s most precious resource. China must spend $162 billion in the next five years to clean up its polluted rivers-as nearly 40% of them are undrinkable. "China has a huge water problem," Legendary investor Jim Rogers says. "…If they don’t solve it, or if they don’t solve it in time, then China has failed." Find out which six global water treatment powerhouses are set to make “liquid profits.”
