Bin Laden Trade

Quite unusual. Whats this Mr Laden doing in financial markets!!!

Ok! here is the story. The open interest in September 700 S&P puts reached 116,000 contracts. Now since the current levels of S&P 500 is around 1450-1500 this is deep in themoney contract and has very least probability. The seller of such an put option would benefit if there is a huge market crash of the order of 30-50% within next three-four weeks. The market gurus says such a crash is highly uncertain unless there is a terrorist attack of the 9/11 attack. Hence this is given the name Bin Laden Trade.

The estimates say the potential loss to the seller could be in billions if there is no crash in the market. Now such a large bet by anyone obviously creating panic in the market leading even to rumors of a terrorist attacks before 21st September.

So does that mean there is really going to be a crash??? Does that mean we all are going to die within next four weeks??? A popular theory doing the rounds and explaining the idea behind this is as follows:

Selling of such a contract is actually done to take money from the market, since credit is not readily available in the market. The theory says that such a deep in the money contract trades on very high premium because the probability of happening that is very low. Now suppose a put contract which in 1000 deep in money would fetch the seller an approximately premium of 900. Now for the seller this is like a loan from the market. Assuming the normal condition when market stays where it is, the seller will loose the bet at the expiry of contract and may have to give the buyer an amount 1000 or so. This difference of 100 can be considered as the interest paid for the earlier loan of 900. This sounds too logical for such an occurance.