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

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:
  1. jhunt commented on Aug 11

    perhaps its not the size we should be looking at but how far away from the current price the strike price was. 2m isn’t that big at all for most funds, but most funds arent making bets that a stock price halves in value in a week.

    i doubt anything could be proven. lucky bastards…

  2. Donkei commented on Aug 11

    This piece from Bloomberg seems to assume that a stock-price decline can destroy a firm. They’ve got the cart before the horse. The firm teeters on insolvency, pushing its stock price to zero, or roughly its value in a BK.

    The real question is whether the put options were bought by insiders. If so, then there are two frauds going on–the fraud of claiming everything is alright a few days before collapse, and the fraud of attempting to profit from it by purchasing puts against the reality that everything is not alright.

    It ought to be fairly easy to figure out if the puts were purchased by an insider, or on insider information.

    But the put options didn’t kill Bear Stearns. Extremely highly levered bets that went against them did.

  3. john haskell commented on Aug 11

    in re jhunt- if the stock is at $62 and you are buying the $50 and $40 puts, it doesn’t seem to me that you are making a bet that the stock price halves. Or maybe my calculator is broken?

  4. scorpio commented on Aug 11

    agree, $1.7 MM nothing to pay by billion-dollar funds to speculate on collapse. and was it even much speculation? the article itself says trade was put on when BSC at $62.50 and the firm’s cash was “depleted” just 2 days later when stock price still at $57.50. obviously someone knew just how bad the situation was, even if the public was still tricked into believing $57 value

  5. Fish commented on Aug 11

    to rationalize these trades as lottery tickets… and throwaway trades is disingenuous. These trades were placed with “knowledge” of the potential demise of Bear. Inaction by the SEC is evidence to me of the sickness of our system.

    The buyer CAN be identified. I’d like to know who it was.

  6. Paul Kedrosky commented on Aug 11

    Yeah, for me the only interesting things were that a) that it was single buyer in size, b) it was way out of money, and c) expiration was looming. Even with that it didn’t strike me as demonstrably illicit.

  7. even a monkeys opinion will get read on the internet commented on Aug 11

    yawn….a lot of people need to re-read Taleb’s missives/interviews/books/etc (see right column)….

    as the BSC extreme-out-of-money put trade is the precise type of black swan trade that he advocates. You’ll lose 99 times, but the win on the 100th try will more than pay off your prior losses.

    Even a $200MM fund (ie a nobody in the hedge fund world) and I can easily afford to make these trades once in a while.

  8. Alex commented on Aug 11

    I’d be curious to know if similar bets were made on other suspect firms. Making one bet on one catastophic collapse and being right is either inside info or very, very lucky. Making a bunch of bets on a bunch of potential blow ups, makes a lot of sense, given the environment at that time.

    Quick question, is it typically cheaper to by a put at 75% of the current price or much lower, say 30%, 10% etc? I’m really not sure, thanks.

  9. eh commented on Aug 11

    It’s not the size of the bet that matters most, but the potential profit — $270m — as the Bloomberg piece makes clear. Are things really so corrupt up and down the street that such an occurrence would be dismissed as cynically as you have done?

    I guess it’s easier to go after the Martha Stewarts of the world.

  10. 2daysinsept commented on Aug 11

    Anyone watching the double shorts? Something ain’t right.

  11. CreditTrader commented on Aug 11

    Just as an FYI – these kind of Option trades are not at all unusual in Capital Structure Arb trades. Given where CDS was trading that week, selling protection against buying puts was potentially highly lucrative and neither bearish nor bullish – although the take under took some of the shine of the protection bet. In this market, deep OTM puts are the hedge of choice as they have a far closer relationship (and delta) to the CDS.
    So buying a few $mm OTM puts versus CDS protection is an arb play and looking at each side individually would provide a very different picture of the supposed views of the investors/arbitrageur. I betcha this was an arb play – especially with the calendar spread reaching across the CDS roll dates – very interesting that the option raders would whine about this as nsider trading…LOL.

  12. OwnPuts commented on Aug 11

    I agree with CreditTrader. Bond holders or CDS sellers buy put options all the time as a hedge.

    Either way Bear was an overleveraged POS that deserved to fail.

  13. bdg123 commented on Aug 11

    $2 million is a pimple but $2 million buying straight puts that aren’t part of a larger managed risk strategy is not a pimple. If that is what happened, there is likely to be dirt behind the story. If hedge funds are making regular $2 million bets on options without using some type of risk scheme, they aren’t going to be in business for very long no matter how big they are because it points to a mindset of extreme risk taking with other people’s money.

  14. Steve Bowles commented on Aug 11

    Sorry but understanding this requires a little more understanding of options. This is more than likely to have been the people selling the 40 and 50 strike puts buying cover. You cant use a risk neutral distribution to price options on dangerous underlyings. You effectively have to buy deep out of the money puts to lock in ‘worst case scenario’ protection.

  15. Prices commented on Aug 11

    The BB article quotes a few people who remark on how ridiculous it is to buy a deeply out of the money put – but it’s clearly not … it’s all in the pricing.

  16. Jim commented on Aug 12

    John Haskell: Your calculator may be fine, but not necessarily your reading ability. The puts in question had strike prices of $30 and $25, not $50 and $40. The latter, higher strike prices were mentioned in a contemporaneous article in Marketwatch that BR quotes, not in the Bloomberg piece in question.

    In any case, the buying of such a large quantity of extremely OTM puts so soon before expiration may have just been a part of a larger risk strategy, or it may been insider thievery. The thing is, we don’t know, and that’s why, considering its enormity, it ought to be investigated.

    If it is NOT investigated, then we are telling the insiders that if they do steal, it will never be discovered. Is that really the message you want to send them?

  17. jhunt commented on Aug 12

    re: john haskell

    oops. it appears mine was broken.

  18. FS commented on Aug 12

    The real issue is legal vs. illegal short selling. I think there are enough facts that support much illegal short selling is occurring as evidenced by the huge amount of fails. Was Bear victimized? Who knows. To suggest that all short selling is on the up and up is like suggesting that Wall Street has sound risk management practices. Gaming the system has occurred on the way up and on the way down. Both situations are not confidence building experiences for any investor.

  19. Wagon commented on Aug 12

    Do you really think that someone working with insider information would lay down such a large bet on a way out of the money option knowing it could be traced back to them? Someone make a good trade and won big. Good for them.

Posted Under