Betting on Bear’s Bust

Today’s most talked about article is likely to be this breathless Bloomberg piece on the demise of Bear Stearns:

"On March 11, the day the Federal Reserve attempted to shore up confidence in the credit markets with a $200 billion lending program that for the first time monetized Wall Street’s devalued collateral, somebody else decided Bear Stearns Cos. was going to collapse.

In a gambit with such low odds of success that traders question its legitimacy, someone wagered $1.7 million that Bear Stearns shares would suffer an unprecedented decline within days. Options specialists are convinced that the buyer, or buyers, made a concerted effort to drive the fifth-biggest U.S. securities firm out of business and, in the process, reap a profit of more than $270 million.

Whoever placed the bet used so-called put options that gave purchasers the right to sell 5.7 million Bear Stearns shares for $30 each and 165,000 shares for $25 apiece just nine days later, data compiled by Bloomberg show. That was less than half the $62.97 closing price in New York Stock Exchange composite trading on March 11. The buyers were confident the stock would crash."

The article goes on to quote a few option traders who thought the bet was extremely unusual and unlikely without inside information.

While there is lots of anecdotal evidence, I remain less than convinced.

A bet of under $2 million is relatively small for any decent sized fund. It was pretty clear at the time that Bear was in deep trouble. And as we noted on the evening of March 10 (Rumor of the Day: Bear Goes Belly Up), paying $4 for a $60 put was expensive.

Here is what was being written at the time:

Options activity is heavily tilted toward bearish bets, with aggressive players buying put options on March options contracts at the $50 and $40 strike prices – which would be an enormous move in the shares, currently trading at about $62.50 a share. Officials at Bear Stearns were unavailable for comment.

However, “it’s very expensive to buy a put” at a $60 strike price, notes Sveinn Palsson, options analyst at Credit Suisse. “You’re paying $4 for a $60 stock, and there’s not much more than a week left in the maturity, so people are just trying to get that cheaper in sort of a worst-case-scenario thing.”

March options expire at the end of next week, so these are short-term bets, but heavy activity is being witnessed in April options as well. Volatility has spiked dramatically in the options as the bearish bets have multiplied; more than 31,000 March put options have traded today, compared with about 16,000 call options. Meanwhile, spreads on the company’s credit default swaps have widened dramatically, to between 700 and 800 basis points, compared with about 450 points Friday.       –Marketbeat

The Bloomberg piece smacks of some historical revisionism . . .

Bringing Down Bear Began as $1.7 Million of Unsuspected Options
Gary Matsumoto
Bloomberg, August 11 2008

Bearish Bets on Bear Stearns
David Gaffen    
Marketbeat  March 10, 2008, 12:16 pm