What's goin' on, 'ere?

In today’s (Friday) DAX options I noticed a few conspicuous (very deep in-the-money) trades in the calls:

Jun 5400 at a premium of 2,175 (almost 2,200 points itm, underlying at 7596, 25 points discount);
Sep 5400 at 2,233 (2,250 points itm, underlying at 7652, 27 points discount);
Dec 5100 at 2,605 (2,643 points itm, underlying at 7743, 38 points discount);
Dec 5200 at 2,498 (2,543 points itm, underlying at 7734, 45 points discount).

Apart from being relatively cheap, what’s the rationale behind these? Why use options so deep itm?

Obviously, I stand to be corrected re the following.

My guess is someone’s running a book. Effectively, all these have a delta of almost 1.0 and zero iv. Therefore, one could sell (covered), for eg, 2 (?) x 0.5 deltas at an iv c. 16% (Jun 7600 last trade at 139).

How many could be sold and still be covered?

Theta is non-existent, but what about the vega (I suspect it’s positive but negligible)?

Next, I looked at the open interest. For calls and puts from strikes 4200 through to around 8200, strikes 200 points apart have open interest greater than the intermediate strikes.

For example, Jun calls (strike first, open interest second):

4200: 4,006
4250: 0
4300: 0
4350: 3
4400: 4,849
4500: 245
4600: 4,020
4700: 140
4800: 4,306
4900: 4,727 and 4,726 for the puts – the exception and obviously part of the same trade
5000: 15,211.

The pattern is similar for Jun puts except 4-5 times larger.

Here’s Dec’s:

4200: 16,993 (calls), 26,308 (puts)
4400: 33,830 (calls), 45,028 (puts)
4600: 20,004 (calls), 27,109 (puts)
4800: 13,557 (calls), 35,777 (puts)

Any comments welcome (apart from, 'I should get out more').

Grant.

grantx said:

Why use options so deep itm?

Click to expand...

As a substitute for an outright in the underlying ?

Profit,

“a substitute for an outright in the underlying ?” Ok. But what is the advantage/difference?

Bit quiet round here these days, isn’t it?

Grant .

Profitaker said:

As a substitute for an outright in the underlying ?

Click to expand...

Is that bullish or bearish?

Thanks.

Hi Grantx,

There are numerous reasons why these trades might take place. A few include:

1) A partial hedge of some more exotic structure (structured derivative, exotic option etc.) with some degree of embedded deep ITM optionality.

2) As above, part of some index or other fund with a built in stop but requiring a delta of 1. For example, many of the capital guaranteed funds combine deep ITM options with a CPPI futures strategy to target n% of the payout on an index with max loss of zero at some future time.

3) One leg of a surface trade (mean reversion based trading of multiple points on the vol surface). Trading ITM with some greeks hedged may give an exposure to a parameter (probably implied vol) that is desirable relative to the same parameter at another point on the surface. Using put call parity we should be able to gain the same exposure using the ITM option in question's opposite delta on the other side of the put / call chain but this may not be feasible for any number of reasons (liquidity etc).

4) I should get on with my research but, last suggestion for now... market maker balancing some unhedged greek exposure at a low implied vol.

Lots of other possibilities but hope these simulate some thought on a few...

NQR

NQR,

Thanks for the (usual) detailed explanations.

If convenient, could you comment on my remark:

Assuming a delta of 1.0, “one could sell (covered), for eg, 2 x 0.5 deltas.”

And where would risks lie (gamma of the shorts)?


Grant.

grantx said:

Assuming a delta of 1.0, “one could sell (covered), for eg, 2 x 0.5 deltas.”

And where would risks lie (gamma of the shorts)?


Grant.

Click to expand...

Not quite sure I follow your Q. Are you suggesting buying 1 x DITM Call with a delta of 1 and then selling 2 x ATM Calls with a delta of 0.5 ? Nothing wrong with that, but why not just sell an ATM straddle ?

Think I've probably mis-read your original question / suggestion ?

Profit,

I don’t disagree with your suggestion but I’m trying to understand any basis for the original set-up.

In addition to NQR’s suggestions above, deep itm (calls and puts) going to the far months of 2008 and beyond suggest to me possibly a market-maker loading up on cheap options, against which numerous strikes can be sold.

Grant.

grantx said:

NQR,

Thanks for the (usual) detailed explanations.

If convenient, could you comment on my remark:

Assuming a delta of 1.0, “one could sell (covered), for eg, 2 x 0.5 deltas.”

And where would risks lie (gamma of the shorts)?


Grant.

Click to expand...

Hi Grant,

Please expound on your remark. I am not sure I fully understand what you are saying.

Do you mean that assuming the deep ITM has a delta of 100 you could short it and cover with 2 * (approx) ATM (50) delta?

Thanks,

NQR

NQR,

Yes, that's it exactly.

Grant.

Guys,

Could you please advise on the broker I can choose to trade Index Options. I am interested on options on theses indices S&P, FTSE 100, CAC40, DAX.

I heard recently that IB has increased their margin by 400%. Is it true?
How about ODL Securities, SucDen?

Thanks in advance,

Gmayha