House Bill: Rating Agency Options Bet Went Up

Discussion in 'Trading' started by livevol_ophir, Dec 14, 2009.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    MCO is trading ~26.62.

    There is a good deal of uncertainty in the credit rating agencies as the government contemplates greater regulation over them. The Credit Rating Agency Reform Bill was recently passed (final approval expected Q2 2010).

    Two highlights are:
    - "credit rating agencies are of national importance"
    - "the Commission has indicated that it needs statutory authority to oversee the credit rating industry."

    Looking at the biggest option trades of the day you can see a developing bet in Moody's (MCO)

    This is opening:
    The Jan 2011 17.5/35 risk reversal was sold 8500 times @ 0.10 (Sell Calls @ 2.05, buy Puts for 1.95) delta neutral against 26.75 stock.

    This is essentially selling a Jan 2011 35 straddle and buying baby puts. The bet is the stock goes to 35 (goes to the short strike) with protection to the bottom.

    Selling the Jan 2011 35 straddle calculations:
    Sell Calls @ 2.05.
    Buy Stock 26.75.
    Synthetic puts = parity + 2.05 - cost of carry
    = (35-26.75) + 2.05 -~0.15
    = 8.10

    So the short straddle receives: 2.05 + 8.10 = 10.15

    Note that selling calls gets short vega (8500 x -.104) and buying puts gets long vega (8500 x .067) for a net short vega position.

    The bet makes ($.104 -$.067)*8500*100 = $31,450 for every vol point drop.

    For what it's worth, reports are being sent out that this bill will reduce the uncertainty in these stocks moving forward. That is a vol decreasing event and this trade gets short a little vega.

    This is an upside bet (even though it is delta neutral) and short volatility.

    For LIVEVOL&#8482 Pro users, I found MCO from the new OTM Puts scan added today.

    You can see payoff diagram, trades and price detailson my blog: