It's Probably Not Another "Bin Laden Trade," But This Massive Mystery Options Play Hints at a Bearish End to 2009

By , Chief Investment Strategist, Money Map Report@kfgtotalwealth

Keith Fitz-Gerald

With the Standard & Poor's 500 Index up 47% from the lows it reached in March, many investors are feeling intense relief.

But with one or more institutional traders making bets that suggest a bearish end to 2009, the question becomes: How do you read this information and what do you do about it?

I'm struck by a sense of déjà vu.

In September 2007, there was a $900 million options wager that became known as the "Bin Laden Mystery Trade." Widely believed to be a massive downside bet on the S&P 500, it was a combination of options totaling 120,000 S&P call options contracts (NYSE: SPY).

Because of its size and the way it was placed, the trade appeared to nervous investors as if somebody, somewhere "knew" something about the S&P 500 being in for a big tumble. Not surprisingly – in this always-anxious, post-9/11 era – speculation about the trade took on a life of its own. In addition to lighting up the chat rooms and conspiracy hotlines, it quickly went mainstream. I recall being asked about it several times on various radio shows and at investing conferences around the world.

I wasn't a popular guy because, instead of playing to the conspiracy theories, I saw another explanation based on 20-plus years of professional investing. As it turns out, I was correct and the trade was some derivation of a "box-spread" options trade.

In case you missed the original article, here's a quick explanation. A box trade is a highly specialized transaction that professional traders or sophisticated institutional investors use on occasion to "box" in the market and guarantee a pre-set level of profits, an acceptable level of risk, or – as may have been the case for that particular trade – it may have been designed to enable an investor (institutional or otherwise) to obtain below-market-rate financing.

This time around, there's a slight wrinkle in that the options seem to be a so-called "put-ratio spread" that expires in December. This transaction calls for an investor to buy a number of "put options," and then to sell more "put options" of the same underlying stock and expiration date, but at a different, lower strike price.

It's a limited-profit, unlimited-risk options strategy that is used when traders think the underlying issue – in this case the SPY – will experience a little volatility in the near future.

According Andrew Wilkinson of Interactive Brokers Group Inc. (Nasdaq: IBKR), an investor last month purchased a "ratio put spread" that expires in August. Wilkinson told Forbes.com that the investor established the bearish trade by using 120,000 "92" strike puts against 240,000 "80" strike puts, a 2:1 ratio established at the equivalent of 920 and 800 on the S&P 500. But as the markets rallied, this investor appears to have closed this trade in favor of a similar strategy involving December contracts.

According to Wilkinson, the trader then moved the long strike up to 95 (the equivalent of 950 on the S&P 500) and sold an additional 240,000 "82" strike puts that would have provided a defense against a market downturn of 14.5% at the time.

Clearly, there is a wide margin for error and a big zone for potential profits if the S&P 500 loses steam. (For reference, the S&P 500 closed yesterday (Tuesday) at 994.35).

In its current form, the options trade appears to have spread out to the point where the ratio spread is no longer clearly visible, or has morphed into an entirely different strategy. But the disproportionately large open interest of 182,157 contracts at 95 and 153,387 contracts at 80 in December seems to suggest that there is still a somewhat sizeable number of traders positioned for a potentially bearish end to 2009.

In addition, based on similarly large and disproportionate open interest in contracts that expire next month, traders seem to have spread their bets out over the third and fourth quarters, which means they're apparently less concerned about the actual timing of any bearish move than they are the actual direction. While they don't mention this in the options textbooks, institutions tend to concentrate their positions in the months coinciding with quarterly earnings reports, since there is more liquidity and depth than in the calendar months.

As of press time, there were concentrations exceeding 100,000 put contracts at the following September strikes: 80, 88, 91 and 95. Any or all of these could be used in conjunction with December contracts to profit if the S&P 500 does drop.

So what does this mean and what can individual investors do about it?

Never one to let the old "X-Files" theme song fade away in my head (okay, I'm a bit of a conspiracy-theorist at heart…), I find it interesting that the initial trade as reported by Wilkinson was 120,000 options contracts. In an era of multi-legged contracts – accounting for hundreds of millions of shares – it's ironic that two disparate trades made nearly two years apart (the "Bin Laden Trade" of 2007 and this latest transaction reported on by Interactive Brokers' Wilkinson) both involve that same number of contracts. Folks tempted to read deeper into the tea leaves than I am may conclude that something sinister is in the works, but at the end of the day I think it's probably nothing more than a coincidence.

As for what this latest trade could mean – well, as was the case with the "Bin Laden Trade," I suspect that there's nothing untoward at play here, either. Therefore, I chalk up the increasingly large positions to savvy traders who understand – as we do – that with the S&P's massive surge since early March, a pullback from current levels is not only likely, but probable.

My view is that it's only logical that traders – the shrewd lot that they are – will want to prepare for that contingency.

If you're of the same opinion and want to play along, there are a number of ways to do so. However, the actual moves you make will depend a lot on your preferences as an investor – as well as your risk tolerance.

For instance, if you're options savvy, you could assemble a put-ratio spread of your own using similar strikes. That way, depending on how far and how fast the S&P 500 falls, you could be sitting on some potentially large windfall gains – while those who didn't prepare for this contingency are forced to conduct financial triage on their investment portfolio.

Of course, if options spreads are not your cup of tea,  you could simply buy a handful of cheap SPY put options, and hope the "lottery" pays off: After all, depending on how deep out of the money you go, your chances of winning would be about the same.
Or, you could buy a specialized "inverse fund," such as the Rydex Inverse S&P 500 Strategy Fund  (RYURX), which actually appreciates as the S&P 500 drops. If you prefer "high-test" investments, you could also opt for a double- or triple-leverage investments – such as the  ProShares Ultra S&P 500 Exchange-Traded Fund (NYSE: SSO), or the ProShares UltraPro Short S&P 500 ETF (NYSE: SPXU).

But tread lightly. In an era where central bankers around the world continue to play "risk taker of last resort," there are no guarantees that we'll see the "normal" market behavior – the market behavior we would normally expect to see after such a torrid advance in a major bellwether index. Things could just as easily power up in a hurry if the markets – and the investors who comprise those markets – become more confident … regardless of the reasons why. In cases like that, these bets would turn into losers in a big way and in a big hurry.

[Editor's Note: The global economic recovery will create an estimated $300 trillion worth of global-investing-profit opportunities. To find out how to capitalize and profit, you just need to know where to look.

And for that, you need a guide. In a free Money Morning Webinar tomorrow (Thursday) afternoon, Investment Director Keith Fitz-Gerald will detail the "$300 trillion global recovery that nobody's talking about" – a recovery that will create some of the most profitable investment opportunities that we'll see in our lifetime. Fitz-Gerald will outline this opportunity, as well as some specific companies global investors might want to consider. To find out more about this free Webinar, please click here.]

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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. 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.

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  • I believe this article tells only half the story. Are we not talking about Sep 2001, not Sep 2007? Prior to Sep 11, 2001 there were massive bets on airline stock prices going down, specifically the two airlines of the downed jets. at 10x the normal amount of put options (1000% increase). The purchasers of those put options made millions. There was a big sell off in the S&P from 1200 to below 900 in 2 weeks prior to 10/6/08. I am unclear why this would be associated with bin Laden. Nothing unusual happened in Sep 07

  • Reading the "tea leaves" is the phrase that jumps out at me -- I really though the Dow would go to 6500 or lower and still believe that all the markets will go lower this fall as the Fed pulls back at the end of October, the "stimulus" paving of interstates nears completion, and folks may get a bit jittery when the jobless rate does not improve in what will, I assert, be a "jobless" recovery later on in late 2010 or even 2011 -- the trade deficit, etc., I've considered that - but average joe is kind of important here -- he's not working, his house is being foreclosed upon, and his buddies see it happening -- I sure as heck am not advising anyone on what to do b/c I don't understand how macroecon. and financial econ. theory got turned upside down so quickly -- or to the average person -- so quickly - -it was really a long time coming and it'll be a long time recovering. Good Luck folks and have fun while you're doing it -- and don't play with money you may need to crack the mortgage, pay tuition, life insurance, property taxes, etc.

  • I'm confused how the trader could stay unknown. Often Pete Najarian talks on Fast Money about someone trading 5,000 contracts of an option as if the buyer has superior knowledge but someone (more likely a group of someones) had to take the other side so that size trade was probably shopped around a few hours? days? Someone knows and it seems like they would talk. Did Bernie Madoff take the other side of the bi Laden trade? - he didn't talk. Thinkorswim says orders for 20 lots get pulled aside and looked at before trading. I know when I'm trying to close 10 lots from relatively illiquid products I get fills if I route orders in 2 or 3 lot increments. Someone is always looking.

  • To Our Readers:

    We received a lot of good comments on this story, both via e-mail and in terms of the comments posted here. We thank you and continue to encourage such strong readers involvement and interest, which makes Money Morning the provocative and informative publication that it continues to be.

    In terms of the contrasts between 2001 and 2007, the writer makes an excellent point. In 2001 there was hugely disproportionate shorting going on that, in retrospect, was clearly related to the horrific events of 9/11. That’s why in Sept 2007 the disproportionately large 120,000 contract position raised eyebrows because people were wondering if it was a repeat situation.

    But even the more-recent situation was backdropped by a great deal of uncertainty, which is what makes these transactions so interesting to study. And as part of our mandate to look for the story behind the story, we'll continue to search out similar topics of interest.

    Many thanks;

    William Patalon III
    Executive Editor
    Money Morning

  • Everything is very open with a clear explanation of the issues.

    It was truly informative. Your website is very helpful.

    Thanks for sharing!

  • It isn't really uncommon for a taxpayer to report less revenue
    on a government tax return compared to is revealed on an info return such as a Type W-2 or Form 1099 if the taxpayer thinks that the amount on the details return is too high.

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