Heya Peeps, What variable in options trading would indicate a higher risk of bankruptcy? - Greeks? - Premiums? - Spreads? - Ratio? For example, would an unusually high premium on a put option indicate an elevated risk of bankruptcy? Thanks, Keith
The best way to gauge the chances of a company going bankrupt is to be golf-buddies with one of the directors, or be a sleeping-partner (literally) with the attractive young PA who works for one of these directors. Seriously dude, trying to link the volumes/strikes/deltas etc of options activity to bankruptcy is extremely far-fetched. I'm not trying to be negative or be-little your question. (PS. The only time there was something 'fishy' was 9/11 - the terrorists funding organisation had bought a lot of put options as they knew the impacting attack was coming. But this only came to light after the attacks. No one would have noticed otherwise. And of course this is the terrorists having insider information....and THAT is what I was hinting at with the golf/shagging-the-PA. You need a man/woman (or non-binary, non-cis, non-whatever-the-new-PC-term-is) on the inside.) Good luck.
Why would options indicate a bankruptcy? If the stock has a chance of going to zero I doubt people are going to be trying to sell into a market that won't buy. Insider trading is probably a leading indicator of problems. If the directors stop acquiring more stock and start selling more frequently something is probably about to go down.
Texaco bankruptcy paid for more prime real estate for CBOE and AMEX traders than any one equity event in my memory. Vol spikes are a first sign and HTB, but obviously they can be wrong. Today pricing the CDS swap is a plus
N(-d2) via Black Scholes Merton Model. Altman Z Score adjusted for Industires might do, when you don't want to value the Equity of non public companies
It's usually the other way around. If there is a high probability of bankruptcy, put options premiums will reflect this. Usually options market makers will change their pricing algorithm to adjust put premiums for higher volatility on the downside, they just adjust based on the probability of the underlying going to 0 (Which is the same as bankruptcy). Deriving the opposite (i.e. getting to know the probability of bankruptcy by looking at put options premium) might prove more difficult. Only if you notice a wide variance between calls & puts implied volatilities compared to historic averages, then you would know that the option market is accounting for a higher probability for bankruptcy. (Usually puts IV is generally slightly higher than calls IV under normal circumstances). Greeks won't show anything (Except Vega as in IV), which automatically reflect in Premiums.
A big portion if not most of the far OTM puts on single names are traded by the credit funds involved in stuff like capital structure arbitrage. There are standard ways to derive the probability of default from the equity option prices, in fact it takes fewer assumptions than back it out from the CDS levels. It's more that supply and demand for these CDS proxy options drives the pricing. There are dealer desks on the street that cater to the capital structure arbitrage players who know both credit and vol, so a lot of the times they serve as a pricing conduit. Regular market-makers are not really in position to see where the credit is trading and end up playing catch-up most of the time.
Except that didn't actually happen. It was fully investigated and the buyers had nothing to do with the attacks and no knowledge of the attacks. Memory's a tricky little fucker.
So if the CDS is undervalued they buy the CDS and Sell the Put Option (and vice versa) untill the two converge back together? Or do you just buy/sell the spread? Valuation via Black Scholes Merton 1-d2 vs the Implied Default Risk in the CDS correct?