Options spike, high put-to-call ratio

Investment Analysis Clubs Macro Economic Trends and Risks
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Options aren’t my thing. I enjoy reading about @captainccs has used covered calls to provide significant income for himself. Other options are much riskier. All options are a bet on the direction of a security or market.

Higher Rates and Tech Selloff Fuel Options Boom

Spending surges on options tied to stocks such as Amazon, Nvidia after shares lose about half their value

By Eric Wallerstein, The Wall Street Journal, Jan. 9, 2023

…
Eyeing quick returns, many traders are selling contracts to reinvest the premium in ultrasafe short-term investments such as repurchase agreements that now offer their most attractive yields in more than a decade.

The trades helped push the weekly amount spent on new put option purchases and sales above $40 billion four times in the fourth quarter, according to an analysis of Options Clearing Corp. data by derivatives-analytics firm SpotGamma. That compares with a weekly average of less than $10 billion through the first three quarters of 2022…

One consequence of the boom in activity is in the ratio of equity put options to call options changing hands on Cboe. The ratio, traditionally seen as a measure of investor angst, recently rose to 2.4, after breaching 1.5 for the first time ever in December…

Despite the appearance of fear, other indicators suggest that options protecting from market turmoil are in low demand. The Nations TailDex, which measures the cost of put options that would pay out in a major S&P 500 decline, recently hit a near-decade low…[end quote]

Nations TailDex is an index measuring the likelihood of a “tail” or “black swan” event. It’s very volatile, with a 52-wk high of 34.75 and a 52-wk low of 5.86. This is exactly the kind of volatility I hate and avoid but I’m sure some high-risk types would schlurp it up.

https://www.google.com/search?client=firefox-b-1-d&q=+Nations+TailDex

Right now, the TailDex index is near a low point. That means the traders of this index don’t think an extreme “tail” event is likely. I agree with that. I think that the Fed has things under control at the moment. VIX is in a neutral channel. The Financial Stress Index is neutral.

But that doesn’t mean the market will rise from here. It just means that the market isn’t expecting a crisis. The market could follow the pattern of lower highs and lower lows that characterized 2022 quite calmly. The equity put options to call options ratio is exceptionally high. If traders are buying more puts than calls, it signals a rise in bearish sentiment.

I plan to wait out the stock market until after the Fed raises the fed funds rate to 5%.

Wendy

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Not just direction, if it were just direction, it would be a lot easier, it is also timing. And timing is [most] often much more difficult than direction.

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I can modify that sentence to:
All [stocks/bonds/ETFs] are a bet on the direction of a security or market.

Also,
A long call plus a short put is equivalent to being long a stock.
A covered call has lower maximum loss than being outright long a stock.
A long stock plus long put may have lower maximum loss than being outright long a stock.
A short put has lower maximum loss than being outright long a stock.

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I don’t see how this can be true. Show me how -

Case 1 - Buy ABC at $X, hold it in your account for the long term
Case 2 - Buy Jun '24 ABC call, sell Jun '24 ABC put.

How much is your account worth in Jul '24 in each case? How much tax is due in April '25 in each case?

It also has a cap on gains. And stocks usually go up with time.

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The easiest way to use options is as a stock surrogate (with, of course, some leverage). For example, BRK is currently at $315 and most would say it has a long-term expectation of going up.

Instead of buying the stock at 315, one could buy a long-term call that expires in January 2025. Hold for one year and sell at the beginning of 2024. Roll over the proceeds then and buy a call that expires in January 2026.

If you buy a call that is deep in the money, say at 200, it will move almost one-for-one with the stock (the delta is 0.95). However, after a year your gain or loss will be a greater percentage.

DB2

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Not quite, it isn’t linear around the starting point. If the market does nothing all year, and BRKB starts 2023 at about 315 and ends 2023 at about 315, the option (Jan '25 200) will not stay at 142. Instead it will decline somewhat because it lost a year of time premium. So holding the stock you gain 0%, but holding the option, you lose probably 7 to 10%. For example, the Jan '24 200 strike option, with 1 year less time premium is $130, or $12 lower.

There are better ways to use options while mitigating some of the loss of time premium. Most common is the simple spread, in a bull call spread (BCS), you buy a lower strike option and sell a higher strike option. You can choose those strikes at will to select your desired risk and potential return.

For example, a rather conservative BCS would be the Jan '25 200/300, you buy the 200 at 142 and sell (write) the 300 at 66, the trade costs you a net of 76. Maximum potential value if BRKB ends anywhere over 300 is 100 for a maximum return of 31% (24/76) over the two years*. That’s pretty good for a relatively conservative trade (what are the odds that BRKB will be over 300 in Jan '25? Pretty high.) The reason the trade “works” is because while your long option (the 200 strike) loses time value, the short option (the 300 strike) also loses time value, and loses more of it, which is a gain for you.

* In the USA, you can choose to exit the trade anytime during those 2 years. Many people are satisfied with 95% of maximum value of their BCS and will exit the trade and use the capital for the next trade.

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A long call, short put (at same strikes, expirys) is sometimes called a synthetic forward or a synthetic long.

There are many explanations online, here is one (Synthetic Long Stock).

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The missing 0.05 to reach 1.00 delta is the time value of the option, a depreciating asset. At expiration, the time value is ZERO. I’ve looked at selling deep in the money calls, they underperform selling at the money.

The Captain

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The premium of calls is a depreciating asset which is why I buy them back early when most of the premium is gone. I usually place a GTC buy back order at half the premium right after selling the call. In a recent post I showed getting 50% of the premium in just 2 days while expiration was close to 30 days away. In my option selector I call it “dollars per day.”

The recent crazy volatility let me resell these options the very same day (round trip) at close to the original premium. Of course, if the stock keeps falling you might as well keep the option position but since there is no telling the future…

Anyone got guaranteed crystal balls on sale? :face_with_monocle:

The Captain

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I know what it is, and I know what it’s called, but I am saying that it isn’t equivalent (as was asserted) in some important ways.

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In the above, I was intending to convey that while options can be quite risky, there are several types of options trades that have less risk than or similar risk to simply being outright long stock. Here, and I think it is obvious, I am speaking of equity risk which is the primary reason for the existence of an equity derivative like an option.

In the case of a synthetic forward, the core economics of equity exposure, for practical purposes with perhaps some technical caveats, are very similar to being outright long stock. Obviously different features of options, like having expirations and embedded interest rates, make those aspects different than simply being long stock.

Synthetic forwards are traded daily in enormous size by institutional trading desks to very closely mimic the economics of the underlying equity risk. At a high level, I don’t think most people who are knowledgeable about options pricing would disagree with the basic premise of the statement “A long call plus a short put is equivalent to being long a stock,” with it being understood that the equivalency is in terms of equity risk (no one would think I mean expiration risk, for example) because a synthetic forward, and its relation to the underlying equity, is one of the fundamental features of options pricing.

I don’t understand that if you say “I know what it is, and I know what it’s called,” that you would also say “I don’t see how this can be true.” If you know what it is, why are you asking for an explanation of this basic feature of options?

You also said, “I am saying that it isn’t equivalent (as was asserted) in some important ways.”

Can you please elaborate on the various important ways that there isn’t equivalency so I can better understand what you are getting at?

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I mentioned a very salient difference above, but you didn’t address it in your later comments. Taxation! With the synthetic position, taxes are due each year at rollover, long-term capital gains rate for the gains on the long call, and short term capital gains rate for the gains on the short put. Over a 10 or 20 year holding period, that makes a big difference. A secondary consideration is the margin requirement for the short put, for a “fair” comparison, some amount of margin tied up at, earning, say, current short-term treasury rates ought to b included in the calculation.

Now don’t get me wrong, if all goes well, and the stock regularly rises each year at a steady rate, the synthetic position will clearly outpace the long stock on a percent return basis. But stocks rarely behave that way. Look at Apple, for example (a prime candidate for synthetic positions), it ended 2021 very close to a high, so the synthetic position did well and was easily rolled over, but it ended 2022 near a low, so the capital available for rollover is much lower. If the put strike and the call strike were too high, a lot of the capital could be wiped out, and you roll over much less.

In the end, like many things, in theory it is equivalent, but in practice it isn’t quite equivalent.

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Thank you for clarifying.

Not sure why you posed a question that you already have the answer to.

Of course closing out a short/long term position will result in short/long term gains/losses.

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Sometimes questions are rhetorical and used to further the conversation. Similar to the Socratic Method. I wanted to focus on the assertion of “is equivalent”.

In summary, it is not equivalent due to:

  1. Taxes due each year rather than just at end of long-term holding. Reduces compounding effect.
  2. Non-linearity around the origin. Causes substantial losses in flat markets.
  3. Dividends are not collected. Synthetic long positions work best with non dividend stocks, but sometimes a company begins/increases a dividend unexpectedly, like Apple did to me.
  4. In the rare case of a market meltdown, a very large part of the deployed capitol is lost (as happened to me in NYA options during the '87 crash). With straight stock, you might be down 30% or 50%, but you aren’t close to wiped out.

All that said, and I suspect I’ve said more than enough :joy:, synthetic long positions can, and do, work very well for short-term traders. You can devote much less capital for a similar return if the directionality works out in your favor.

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What variable is nonlinear and what is the origin?

Synthetic forwards are linear with respect to underlying equity price movements.

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If the stock does nothing all year and ends at (or near) the same price then the direct share investment gains nothing and loses nothing. But the combo options investment (synthetic stock) likely loses a bit because the long call will drop more than the short put rises. For example, if you want synthetic Apple stock, you buy a Jan '25 130 call for ~$30, and you sell a Jan '25 130 put for ~$17. If the stock does nothing over the 2 years and ends at 130, the call is worthless and the put is worthless, and the trade loses ~$13.

The origin is the stock price when entering the trade. Usually the graphs showing combo trade losses/gains with price on the X axis put the starting price as the origin.

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