By Keith Fitz-Gerald
It’s Friday morning, and the $900 million ‘Mystery Trade’ that I’ve written to you about several times recently expires today.
This trade, which, especially in chat rooms frequented by conspiracy theorists, will likely expire having served its purpose as a below-market-rate financing mechanism for some investor or institution. And that’s a good thing, because it proves that even unusual activity can have a perfectly rational explanation, even if the circumstances surrounding it remain an enigma.
For those of you who are reading about this admittedly fascinating situation for the first time, let me take a moment and give you a quick overview.
The Lowdown on the ‘Doomsday Trade’
On Sept. 5, 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).
So, why all the fuss? Viewed at face value, this trade looked to many investors like someone was making a big bet that U.S. stocks were in for a huge tumble, almost as if whomever placed these trades “knew” something ominous was afoot. At the time, the S&P 500 was trading at roughly 1470. From this vantage point, these strike prices equated to the S&P dropping from that level all the way down to a range between 600 and 950 for a decline of between roughly 36% and 59%.
[From current levels of about 1518, we’d now be talking about a decline of between 40% and 63%.]
When these trades were viewed from that vantage point, they certainly were fear inducing.
But as a professional trader, I could see that it was very possible these were set up as a so-called “box-spread trade.” This 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.
As it turns out, that is just what it apparently has turned out to be… a box-spread trade of some type.
As I’ve mentioned before, we were the first news service to report these trades; until we did so, news of the options deals had been confined to websites and chat rooms. But once we reported the story, scores of other media organizations began talking about the options deals, too. These media organizations seemed to fall primarily into one of two camps in terms of how they interpreted the trades:
- The first group, the majority of the media folks, agreed with my take that there had to be a logical explanation for the trades.
- The second group, the minority, couldn’t let go of the theory that there must be a more-sinister motivation.
Speaking of which, the odds are very high that we’ll never know who placed the trade, or exactly why they did it, but for the most part that’s irrelevant anyway.
But at the end of the day, the really vital thing to understand about this trade is that the capital markets worked the way they were supposed to and at a time when there was unprecedented potential stress, thanks to a worldwide liquidity shortage stemming from the subprime-mortgage mess.
That’s actually a very big deal. Personally, I find that reassuring, and I hope you do too.
A P.S. from the author: As of press time today (Friday), I’ve seen no evidence that this trade was rolled into subsequent months. But the day as they say in those great old cowboy Westerns “ain’t over, yet.” Rest assured that I will be watching vigilantly and that I’ll make sure to keep Money Morning subscribers informed.
But it’s been a fascinating and rewarding experience. As a relatively new news organization, not to mention one with a highly specialized focus, it’s been very gratifying to actually experience a major news “scoop” so far ahead of our newsgathering rivals. 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.
One of the ways we do that is by tracking money flows, hence the name of our monthly sister publication, The Money Map Report. And I’m sure it’s no surprise to you that much of those money flows are flowing into – or out of – China.
If you’re just starting to add international investments to your holdings, or want to invest some money in China, consider either a very good Exchange Traded Fund (ETF) that’s investing in Asia, or even better directly into China.
That will provide you the long-term benefits of China’s continued explosive growth, while also giving you the diversification needed to rise out that economy’s inevitable swings. One top-performing mutual fund is the China Region Opportunity Fund (USCOX), which is managed by U.S. Global Investors Inc. (Nasdaq: GROW) – a great example, by the way, of a company that will be profiting indirectly from China.
I mention the China Region Opportunity Fund and U.S. Global Investors because the fund-management firm is well run, and its funds are well managed. The company is a favorite of several of our analysts – myself included – here at Money Morning.
Related News and Story Links:
- Money Morning Investment Analysis: This $900 Million Bet Has Global Traders Talking.
- ‘Air America Radio.’
- The Street.com TV Interview Video Clip:
About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean, and he's also the founding editor of Straight Line Profits, a service devoted to revealing the "dark side" of Wall Street... In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.