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TheDude

The Impact of Delta Hedging

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This was sent to me from a friend - it was originally sent from the CIBC prime brokerage desk.

 

Are you sometimes trying to put your finger on what just caused that sell off? We think a few large S&P 500 option trades yesterday can help shed some light on delta hedging. If we hypothesize that 4 trades listed below are all related and from the same investor we can likely explain the start of yesterday late morning sell off of the S&P 500. The dealer that facilitated these trades (assuming this is the scenario) would likely need to delta hedge approximately $1.2B in the S&P 500. If your curious the investor collected $28M in premiums on this trade for being net short.

 

Option Trades:

Bot 17k Dec 1350 calls

Bot 25k Mar 1500 calls

Sold 8.4x Mar 1400 calls

Sold 60k Dec 1450 calls

 

These trades took place between 11-12 EST yesterday. Im sure we can see the chart for ourselves and note what happened next....

 

I thought this was interesting for 2 reasons:

1. To show the sort of money that is being made EVERY DAY in the markets.

2. After looking at your charts, ask yourself why these trades were done when they were.

 

Food for thought?...

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Food....

1....if that was an opening trade, then no one has made any money yet!!!!

unless the market makers were able to reduce their previous book risk via these trades

Plus 28mil of premium for that risk (1.2bill is only the hedge amount not the exposure) - not a huge amount, but not bad returns.

(I dont trade the SP, what is the exposure for each contract? This will give a better insight into the risk v return)

 

2....

They have done two ratios (assuming I have copied this right)

Dec...+17.5k 1350 calls, -60k 1450 calls (or alternatively they are long the 1350-1450 call spread 17.5k, and naked short 42.5 1450 calls)

Mar -8.4k 1400 calls, +25 Mar 1500 calls (or alternatively they are short the 1400-1500 call spread 8.5k, and long 16.6k mar 1500 calls)

 

A little table to help show things.

 

Strike........DEC................MAR.......

1350.........+17.5............................

1400...............................-8.5........

1450...........-60...............................

1500................................+25..........

 

So ideally they want the market to stay around 1400-1450 - until DEC expires, and then they want the market to run really really hard through 1500.Other alternatives will get them some positive outcomes also .....

 

Re delta hedging - you need to know the deltas of the individuals, add them up and work out the total required to hedge it. One might assume given the market move you mentioned that it was not a delta hedged trade, and that one side of the trade (likely the market maker group ) had to do the hedging (again - i dont trade the ES and dont look at it, so largely speculation)

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Re delta hedging - you need to know the deltas of the individuals, add them up and work out the total required to hedge it. One might assume given the market move you mentioned that it was not a delta hedged trade, and that one side of the trade (likely the market maker group ) had to do the hedging (again - i dont trade the ES and dont look at it, so largely speculation)

 

This trade was executed "live" thus hedged by participating counter-parties. Morgan Stanley I believe was the desk responsible for execution and clearing. Quoted on a cash-basis, the original order was for 50% of the size - minutes after execution, the desk returned to the floor to double the trade size. I assumed it to be a positional adjustment.

 

Spread was quoted referenced ES.U 1423.00, and executed with futures trading between 1420.00 and 1422.50. As option models differ, thus delta estimates will vary. My model placed the delta of the entire trade at approximately $850,000.

 

While I'm not 100% certain of the counter-party's identity or initial position, I believe the trade was closing/rolling ~40k of the Z 1450 C bought weeks prior for $20.00-20.30 15k times initiated trading 1362.00 ESU and scaled into throughout the ensuing rally.

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