Dig into a big NDX sell gap


On Tuesday, August 23, I was forwarded the image below showing high volume and open interest in two NDX put options that are about 30% out of the money. The image included a note asking if I had any idea of ​​the motivation behind the trade. The first step was to determine which of the two contracts was sold and which was bought, as well as the trades that led to open interest in almost 7,000 contracts.

Source: LiveVol.com

Drilling down the band over the past few trading days, we found concurrent trades for every contract every day since Monday, August 15th. Not surprisingly, the trader sells the NDX Oct 9200 Put and buys the NDX Oct 9175 Put as is typical for vertical out-of-the-money spreads. Every day the volume has fallen between 500 and 2000 contracts and the total position size is 7750 contracts. The table below shows the volume per day, the average price for each option and the credit for each bull put spread, which ranges between 0.21 and 0.38 depending on the day.

Table

Sources: LiveVol.com and EQDerivatives calculations

Using VWAP for all trades, the current position is 7750 NDX Oct 9200 Puts short and 7750 NDX Oct 9175 Puts long for an average credit of 0.26. The gain chart below shows the gain at expiration based on the full position.

Table

NDX’s closing price ranged from 12881 to 13667 over the seven trading days this position was executed. The dollar risk versus reward is shown on the payoff chart above and the potential loss (-24.74), based on a dramatic drop in NDX, is substantial versus reward (+0.26) . However, a lot of things have to go wrong for this trade to be in jeopardy.

Depending on the day, the spread’s 9200 short strike was between 28% and 33% lower than the NDX close. We collected NDX data going back to 1985 and compared historical price action over the same time period as this trade to determine how often it would generate profits. We also explored how often the 9200 short put option would be in-the-money at any given point in the trade’s duration. This additional analysis offers an idea of ​​the likelihood of this trade causing concern about taking a loss on this position.

Table

Sources: LiveVol.com and EQDerivatives calculations

The distance to the 9200 sell column indicates the price change needed to reach 9200 based on the NDX close each day. The last two columns show what percentage of sightings would result in an NDX below 9200 at expiry and how often, based on history, the 9200 price level would be breached during the duration of the trade.

Note that around 2% of historical price action would cause concern for this trade since the short strike would be in-the-money. Checking the odds at settlement, this figure ranges from 0.61% to 1.30%, with the most recent trades having the highest odds of not working, at least based on history. We will certainly be keeping an eye on the 9200 price level until the third Friday of October, but probably not as closely as the trader behind this bullish spread.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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