“The fez (Turkish: fes, plural fezzes or fezes, from Arabic Faas ” فاس “, the main town of Morocco before 1927[1]), as well as its equivalent, the tarboosh (Arabic: طربوش, Egyptian Arabic pronunciation: [tˤɑɾˈbuːʃ], ALA-LC: ṭarbūsh), is a felt headdress of two types: either in the shape of a truncated cone made of red felt, or a short cylinder made of kilim fabric, both usually with a tassel attached to the top. The tarboosh and the modern fez, which is similar, owe much of their development and popularity to the Ottoman era.” (source Wikipedia)
Ticker: $FEZ “SPDR EURO STOXX 50 ETF is an exchange-traded fund incorporated in the USA. The ETF tracks the performance of the STOXX 50 Net Return Index holding European blue chip stocks. The fund typically invests in Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands and Spain. The ETF generally invests at least 80% of its assets in the underlying index using a sampling strategy.” (source Bloomberg)
Today we’re wearing our option trading hat, so we’re talking about the latter, the SPDR unhedged EURO STOXX 50 ETF, and the unusual trade we saw. Today at 10:43, 20,000 May 34 calls traded at 1.42, and .493 for 60,000 August 37 calls, as a package. Both legs were labeled opening according to the exchange data provided by Trade-Alert. Fred Ruffy of Trade-Alert suggested that the initiating trader bought the May 34 calls and sold the August 37 calls in a ratio 1×3 spread.
Buying the August 37s to sell the May 34s is probably the better side of the trade for a directional trader to play though, assuming they can manage their position. If one bought 3 August 37s for .50 each, while selling one May 34 at 1.42, that package would cost $8.00 (recall that each contract represents 100 shares.) That is the most a trader could lose if FEZ remains below the 34 strike between now and May expiration. If FEZ rallies through the $34 strike a May 34 call option will appreciate more rapidly than an August 37 call because it has a higher delta. Delta is the term options traders use to describe the rate of change in an option’s price with respect to changes in the price of the underlying security. Moreover as the price of FEZ increases, the delta of a call option may also increase up to the point where it will behave essentially like the underlying stock. However in this example one would own three times as many of the August calls as one would be short the 34s. That ratio makes all the difference, consider…
- The FEZ May 34 calls have a delta of 55. That means that these calls will change in value at 55% of the rate of change in the underlying security, FEZ. So for example if FEZ rises by $.50, then these calls will rise in value by about $.28 per share x 100 shares = $28
- The FEZ August 37 calls have a delta of 24. That means these calls will change in value at 24% of the rate of change in the underlying security. So if FEZ rises by .50, each call will rise in value by $.12 per share x 100 shares = $12
Using some simple arithmetic we can calculate the delta of the package.
It’s important to note that both the value of an option, and its sensitivity to changes in price, volatility and other factors changes as a function of time. To reflect this the graph below shows how the value of this position would change as a function of changes in the underlying price right now (in pink) and what the likely values of this position would be on the May expiration date. What we can see is that at May expiration, this position is likely to lose money between approximately $35 and $37.50, but will likely be profitable below $34 and above $37.50. This is admittedly a wide band, particularly considering FEZ represents a blue-chip index, however that seems an ok tradeoff given that it may be possible to monetize a directional move well prior to then.
