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Options insanity - stupid "rich" skew in Apple and others


aws
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I'm referencing a couple of articles I had seen today about unusual occurrences in options pricing which may both be contributing the the melt-up behavior we are seeing in stocks like Apple and Tesla, and might also present opportunities to take advantage of the pricing aberrations.  Here are the links:

 

https://www.thebeartrapsreport.com/blog/2020/09/01/stupid-rich-skew/

https://www.zerohedge.com/markets/apples-market-cap-surpasses-entire-russell-2000-due-option-insanity

 

The gist of it is that put/call ratios are at record lows, which results in calls being considerably more expensive than puts, and furthermore very far out of money calls are relatively more expensive than nearer the money calls.  The first article references the following trade:

 

"Think of the January 2021 expiration. The client bought the $200 call and sold the $250 call, 1 x 4, and got paid $3.50 to put the trade on.

 

Apple was worth $1.5T at the end of July and today she stands tall at $2.2T. In order for the client to lose money* at January expiration, the stock has to breach $270 ($129 today), which would put the company’s market capitalization very close to $5T, by January 2021, that is a little over four months away.

 

*The mark to market in the short run can be extremely painful though – if Apple equity soars another 10-20% (Apple is up 50% since late July), that is indeed the catch. AAPL is trading nearly 65% above its 200-day moving average vs. 42% in February’s great bull run."

 

The most likely occurrence would be that Apple does not rally a further 60% in 4 months, and that both halves of the option expire worthless, and the trader keeps the option premium received.  But even in the event that Apple does get above $200 by January, you have further upside participation, and you only begin to lose money at what should be an absurd price beyond anyone's price target no matter how much multiple expansion the analyst wants to add to their model.

 

Another example would be Tesla.  Here a 1:4 ratio seems way too dangerous, but the skew is so much greater that you can get a similar result with just a 1:2 ratio.  Consider a January 2021 600/800 1:2 call spread.  The 600 call costs $73 and the two 800 calls sell for $41 each, for a net credit of $9.  In this trade you would keep $9 if both halves expire worthless, and you would have upside participation up to $209 max profit between 600 and 800, starting to lose back after that point and breaking even at 1009.  A 1009 stock price on Tesla in four months, especially when considering dilution from options, would be well in excess of a $1 trillion market cap, making them bigger than ALL other publicly traded automobile companies combined.

 

Both of these trades have inherent unlimited risk by being short more call options than owned and are certainly not right for everyone, but this environment should also be making put options especially cheap even with stocks at all time highs.  What do you think  would be optimal put option strategies in this environment?  Basic protective puts seems like a no brainer if you envision any chance the current environment might be reversed at some point, although the current dynamic pushes you further and further away from the money every day, as any puts bought last week would be significantly underwater after the moves so far this week. 

 

Can you think of other creative ways to play the skew?  Even vanilla call spreads without ratios look increasingly attractive as the higher leg pays for much more of the lower leg than normal, but that would require expecting to buy into the melt-up rather than profit off of its ending. 

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With put options being so cheap, you could sell 1 ATM put and buy ~2 OTM puts with the proceeds. Get 2x the downside protection with no cash outlay.

 

For example, selling Dec 135 Puts for  $13.93 (mid price) and buy 2 Dec $117.5 Puts for $6.58 (mid price).

 

You net $77 on the transaction and will profit at prices 13% below today's price. If it keeps going higher, you lose nothing (rather gain $77) and if it drops more than 13% you have the 2x the put protection.

 

Worst case scenario is that AAPL only falls to $118 leaving you ~$1,700 bucks - but if it falls, I think it's likely to fall more than 10% just given the size of the rally preceding that and it's current 41x P/E.

 

 

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With put options being so cheap, you could sell 1 ATM put and buy ~2 OTM puts with the proceeds. Get 2x the downside protection with no cash outlay.

 

For example, selling Dec 135 Puts for  $13.93 (mid price) and buy 2 Dec $117.5 Puts for $6.58 (mid price).

 

You net $77 on the transaction and will profit at prices 13% below today's price. If it keeps going higher, you lose nothing (rather gain $77) and if it drops more than 13% you have the 2x the put protection.

 

Worst case scenario is that AAPL only falls to $118 leaving you ~$1,700 bucks - but if it falls, I think it's likely to fall more than 10% just given the size of the rally preceding that and it's current 41x P/E.

 

That sounds quite risky writing (naked) an ATM put for a stock trading at all time highs. Wouldn't that leave you wide open to get assigned? Unless I'm not understanding this correctly.

 

If put options are so cheap then why not keep it simple and buy long dated puts?

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With put options being so cheap, you could sell 1 ATM put and buy ~2 OTM puts with the proceeds. Get 2x the downside protection with no cash outlay.

 

For example, selling Dec 135 Puts for  $13.93 (mid price) and buy 2 Dec $117.5 Puts for $6.58 (mid price).

 

You net $77 on the transaction and will profit at prices 13% below today's price. If it keeps going higher, you lose nothing (rather gain $77) and if it drops more than 13% you have the 2x the put protection.

 

Worst case scenario is that AAPL only falls to $118 leaving you ~$1,700 bucks - but if it falls, I think it's likely to fall more than 10% just given the size of the rally preceding that and it's current 41x P/E.

 

That sounds quite risky writing (naked) an ATM put for a stock trading at all time highs. Wouldn't that leave you wide open to get assigned? Unless I'm not understanding this correctly.

 

If put options are so cheap then why not keep it simple and buy long dated puts?

 

You're only "naked" between 135 and 117.5.

 

Given that the stock is 60+% above it's 200 DMA, I'm not thinking a 13% move to the downside would be viewed as extreme in a correction. Anything beyond 13%, you're getting paid for an option that cost you nothing. And again, max loss is ~$1,700 with a target gain of $3,600 and no up-front cash needed (other than maybe to cover the $1,700 unrestricted if in a non-margin account).

 

At any loss in excess of -13%, you win. At anything in excess of +0%. You win. Only lose between -13% and 0%

 

In other words: no theta decay, no penalty if it keeps rising. Only penalty is of $100-$1,700 if it doesn't go down enough.

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Edit: Here's another recent article on the topic:  https://www.bloomberg.com/news/articles/2020-09-01/nasdaq-volatility-twist-prompts-theories-on-storm-in-tech-stocks?sref=dukn3Rgh

 

I've been trying to play around with the skew analysis tool in IBKR to help visualize it.  Even if I don't fully understand everything that is going on you can clearly see the skew has increased vs. yesterday, and more vs. a week ago, and much more vs. a month ago.  This is for Apple January 2021 options.  250 strike calls are now trading up to a nearly 70 IV.  The highest strike calls available a month ago were a lot lower, but then the $145 calls traded with an IV of just around 33 vs. over 50 today.

Capture.thumb.PNG.568f310ae10c9138aa5534932585f626.PNG

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On this subject, there is a theory floating around that market-makers are pushing Tesla higher because they buy the stock to offset their risk on the calls. it's a virtuous cycle - the more calls are bought, the more they have to buy the stock, pushing it higher, which entices more call buying.

 

Could that be true?

 

 

 

 

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On this subject, there is a theory floating around that market-makers are pushing Tesla higher because they buy the stock to offset their risk on the calls. it's a virtuous cycle - the more calls are bought, the more they have to buy the stock, pushing it higher, which entices more call buying.

 

Could that be true?

 

There has been suspicious call option activity for a while in Tesla.  What you are referring to has been called a gamma squeeze.

 

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The virtuous cycle aspect is certainly part of the theory.  The market makers need to delta-hedge their net positions, and because lately so many more calls than puts have been traded they are net short from options they wrote and need to buy shares to hedge.  The net purchases start to move the price up, which brings more options into the money, which requires additional shares from the market makers to hedge their options books so they buy more, and so on.

 

I think the moves are especially significant as of late is because there is still so much FOMO call buying up at all time highs, even when volatility has been bid up, whereas usually you would expect a lot more people buying protective puts to lock in gains and then the dealers wouldn't be so net short from their options writing.  They are saying the only other time the vix has been this high at a market all time high was back in March of 2000, and you know what happened after that.  The 1 month out vix futures are all the way up at 30, and then you have the options on the biggest company in the world trading at an IV of 70 for options months in the future.  Many companies have much lower IVs than that on earnings report weeks.

 

I would think there must be some good ways to take advantage of this.  I always like trades where you are betting against something that seems impossible, like trade idea from quoted in my first post of a 1:4 200/250 call spread, where the only way you can lose is if Apple more than doubles again in the next 4 months, but it's hard to do much in that trade.  Even if I think there's no chance of losing money in the end, things can always get wild in the short run being net short 3 calls for basically just a 1% premium each, and so to be safe it has to be almost an absurdly small position, and it might be taking the place of a similar type bet that has similar odds but might payoff a lot more.

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On this subject, there is a theory floating around that market-makers are pushing Tesla higher because they buy the stock to offset their risk on the calls. it's a virtuous cycle - the more calls are bought, the more they have to buy the stock, pushing it higher, which entices more call buying.

 

Could that be true?

 

I do think there is some thing to the hypothesis that bullish option bets are driving the market higher. certainly the counterparts to an option buyer (whether it be a market maker or another institution) would need to hedge and probably buy the underlying.

 

The other interesting tidbit about the market is that despite having very limited downside volatile recently, the VIX isn’t really going down, in fact it seems to creep up and was at 26.5 today. That’s historically quite a high value. We were around 14 at the beginning of the year for example and everything above 20 is pretty high. This is likely due to some hedging.

 

I think Right now, the Momentum up feed on itself. As a large Institution, you can’t really afford to be out of the market and bonds don’t yield anything, so no alternative except maybe a bit of gold or bitcoin. So it’s probably trendfollowers doing their thing until the trend breaks. I do think that these type of markets are more prone to volatile events and sharp corrections.

 

It is probably not productive to overthink this as there is no way of knowing who does what and why and does it even matter.

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Even if I think there's no chance of losing money in the end, things can always get wild in the short run being net short 3 calls for basically just a 1% premium each, and so to be safe it has to be almost an absurdly small position, and it might be taking the place of a similar type bet that has similar odds but might payoff a lot more.

 

I came to the same conclusion after looking at the payout structure of this trade. In the video discussing the gamma squeeze theory, the guy posited that this melt up ends when the premiums for short calls justify stepping in front of the freight train (9:50 in the video). I do not think we are at that point yet, atleast w/ AAPL.

 

The TSLA long $600 and short $800 Jan 2021 1x2 looks more attractive. Still some pretty crazy exposure in the short-run, especially for a recent college grad like myself.

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And now we are starting to see the vicious side of that virtuous cycle as dealers sell off their hedges, more people buy puts to balance the put/call ratios, and IV increases makes it more expensive to chase the stocks up further.  The past few days like this such as June 11th and July 23rd turned out just to be blips with stocks continuing on to even higher levels within a couple of weeks.  Who knows if this is the start of a real change, but it was interesting to note that the vix level at the close yesterday was the highest it has ever been at an all time high close for the overall market... the second highest such close was in March 2000.

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If you bought any decently long-term options last week you might have made money whether you bought puts or calls. 

 

Those $800 TSLA calls I mentioned in the first post traded at a split-adjusted price of 18 when the stock was at 442.  Today it's 26 with the stock at 407 - so nearly a 50% gain over a week with the stock down 8%.  $350 puts for the same date were 43 last Friday and 63 today.  So those are up about 50% as well.  Guess I should have bought straddles and made money or both sides.

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With put options being so cheap, you could sell 1 ATM put and buy ~2 OTM puts with the proceeds. Get 2x the downside protection with no cash outlay.

 

For example, selling Dec 135 Puts for  $13.93 (mid price) and buy 2 Dec $117.5 Puts for $6.58 (mid price).

 

You net $77 on the transaction and will profit at prices 13% below today's price. If it keeps going higher, you lose nothing (rather gain $77) and if it drops more than 13% you have the 2x the put protection.

 

Worst case scenario is that AAPL only falls to $118 leaving you ~$1,700 bucks - but if it falls, I think it's likely to fall more than 10% just given the size of the rally preceding that and it's current 41x P/E.

 

+1 on this. This got me thinking a bit and I put on a similar but slightly different trade in AAPL and a few other names. Thanks for the unique idea.

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With put options being so cheap, you could sell 1 ATM put and buy ~2 OTM puts with the proceeds. Get 2x the downside protection with no cash outlay.

 

For example, selling Dec 135 Puts for  $13.93 (mid price) and buy 2 Dec $117.5 Puts for $6.58 (mid price).

 

You net $77 on the transaction and will profit at prices 13% below today's price. If it keeps going higher, you lose nothing (rather gain $77) and if it drops more than 13% you have the 2x the put protection.

 

Worst case scenario is that AAPL only falls to $118 leaving you ~$1,700 bucks - but if it falls, I think it's likely to fall more than 10% just given the size of the rally preceding that and it's current 41x P/E.

 

+1 on this. This got me thinking a bit and I put on a similar but slightly different trade in AAPL and a few other names. Thanks for the unique idea.

 

Glad it helped!

 

I also put on a very similar trade the one described above the morning after posting. We'll see how it turns out!

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https://www.ft.com/content/75587aa6-1f1f-4e9d-b334-3ff866753fa2

 

SoftBank is the “Nasdaq whale” that has bought billions of dollars’ worth of US equity derivatives in a series of trades that stoked the fevered rally in big tech stocks before a sharp pullback on Thursday and Friday, according to people familiar with the matter.

Weren‘t  these calls just bought from huge gains from recent trades/sales they did? Maybe they still work out if they are long dated. If SoftBank indeed can unload ARM Holdings, which seems to be a total dog (based on lack of revenue growth and profits since acquired) then they really did hit some jackpots, while also getting good value out their dogs (Sprint, ARM Holdings) except maybe Wework. For a venture fund , that’s actually a pretty good outcome.

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  • 3 months later...

Hi Folks,

 

Can you please share what do you use for options charting? What do you find the best or few of the best that you use on a regular basis?

1. comparing the option price vs the underlying

2. different expiries and behaviour

3. past vs present. past behaviour, etc.

4. and many more relevant data to overlay

 

IBKR? Barchart? Etc

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Anyone still looking at stuff like this? Was looking out at the June puts around $100-110 and they look reasonable/inexpensive. Haven't dont anything yet but 30x+ on this probably presents some decent downside should things not go as planned.

 

Still looking - my last Apple puts spreads that were opened at the peak in September were going to expire with a smallish ~10% loss associated with them. Rolled them forward a few weeks back with February maturities to retain some of that time value and recycle it into a new position.

 

Still thinking this pays off over time - in the meantime I'll actually be paid time value to wait and still don't think a 20-30% decline back to just the 200 DMA doesn't seem like an especially high bar to profit from.

 

 

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