Let’s just get down to it: market makers badly mispriced Intel (NASDAQ:INTC) options, specifically bear put spreads, creating a phenomenon I have termed “risk inversion.” Such undercurrents rarely materialize. However, with the unprecedented trade war on our hands, Wall Street is attempting to adjust for perceived volatility.
The thing is, much like the anticipation of the needle entering the vein for a medical checkup, the pain in our heads is often much worse than actual sensation involved. Often, we walk away with a relived look, thinking, “that wasn’t too bad.”
When it comes to high finance, though, that thought process comes with real financial consequences if the underlying risk was modeled incorrectly. With bear put spreads for INTC stock, the argument is that maker makers reacted too aggressively to the volatility, thus creating unique potential opportunities for bold speculators.
Again, let’s keep the tone brutally frank and transparent: when INTC stock dropped 7.66% on Thursday following a robust midweek performance, it scared the [expletive] out of Wall Street. Generally, blue chips — even ones that are going through challenging times like Intel — don’t see such wild gyrations within 48-hour cycles.
With market makers providing liquidity managing massive exposure, this overriding reality forces them to be conservative, especially after big moves like was witnessed in INTC stock yesterday. That’s almost certainly why you’re seeing risk inversion in certain INTC put spreads.
Under an ordinary bear put spread transaction, you buy a put option and simultaneously sell a put at a lower strike price (for the same expiration date). The idea is to use the credit received from the short put to partially offset the debit paid for the long put, effectively creating a discounted net bearish position.
Nevertheless, even with this setup, the transaction itself is a debit-based strategy: you pay a debit for the speculation that the underlying security will fall in value. On the other end of the transaction, put spread sellers deploy a credit-based strategy. They receive the premium of the event that you’re speculating on; in this case, the speculation that INTC stock will fall.
To put it simply, debit-based strategies like the bear put spread start off in a cash outflow position. In order to break even and hopefully profit, the stock has to move in the right direction (which is down for a bearish transaction).
When I talk about risk inversion, the debit-based strategy already starts off profitable on paper! That means that if nothing happens (let’s say the stock stays stagnant), you end up collecting money (as in a credit spread) as opposed to generating alpha.
Traders who are looking for the closest thing to a free lunch should consider the 21.50/20.50 bear put spread for the options chain expiring April 17. Immediately, you can tell that this put spread is risk inverted because INTC, from Wednesday’s close of $19.88, must “fall” to $20.50 to be fully profitable.
Put another way, INTC stock can rise about 3.12% and this put spread would still qualify for the maximum payout of nearly 43% at expiration.
And what are the chances that INTC will not rise by a 3.12% margin for any given week? It’s a lot better than the 63.7% probability of profit that Barchart calculated, which makes this put spread favorably inefficient.
