Buying deep OTM puts

Q

Quant Dracula

Hello all,

I have been browsing for a while and recently joined as a poster.

In August this year I purchased spot month (September) 70% puts on the ASX200 for 2 points. (The reason for the purchase was as part of a spread and not for speculative purposes, I was completely prepared to wear this cost).

Only a few days later I was shocked to have seen these puts balloon in value from 2 to 14 points when the underlying had only moved down about 2%.

I had a look behind the reasons why they increased in value so much, and from what I can gather it looks like the term structure jumped from being upward sloping to downward sloping and as these puts were at the very front end they benefited from it.

I am curious on people's opinions whether this is a fair reason for such an increase in value or would there be another cause.

Thanks

Dracul
 
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Somebody got a taste of the dragon

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Bry - yes you are right. My question pertains to the reasons for a 7-fold increase in the price for an option that was still way OTM on a comparatively minor move in the underlying.
 
Maybe Australia didn't plunge as much as here in US? The VIX went off the charts. It was not a minor move at all, but very violent and made volatility spike in many options, even calls. No doubt they didn't stay at 14 for long. Am I right?
 
Quant Dracula said:
Bry - yes you are right. My question pertains to the reasons for a 7-fold increase in the price for an option that was still way OTM on a comparatively minor move in the underlying.
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I'd jump in with something useful but don't speak "option greeks", I only understand partial derivatives. I'd say, w/o seeing what you'r talking about, that suddenly there was increased demand for those puts as the underlying tanked -OR- threatened to tank, for whatever reason, that's the causation. As a result, your dO/dt went & got railed while your d2O/dt2 took things to another level.
 
I just checked the asx 200 vs the s & p 500 charts. They both plunged over 10% in 2-3 weeks. For a major index that is not a minor move in the underlying. It is a lot of volatility, and that is what made your options spike in value.

Your price spike was about the volatility. The sudden rapid price movement "threatened" to put the options in the money, so the price went up a lot, but only temporarily.
 
Hi Bry. Yea you're correct on both accounts - they dropped off very quickly again in value and we didn't have the same sharp drop as the US intra day. However while the options around ATM went up, they certainly didn't go up in this magnitude.

I'm interested in how these puts behaved and the reasons behind it from a tail risk hedging point of view.
 
Bry said:
I just checked the asx 200 vs the s & p 500 charts. They both plunged over 10% in 2-3 weeks. For a major index that is not a minor move in the underlying. It is a lot of volatility, and that is what made your options spike in value. If they are not close to being in the money, then the price is probably close to the $2 you originally paid. It is about the volatility. The sudden rapid price movement "threatened" to put the options in the money, so the price went up a lot, but only temporarily.
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Thank you gentlemen, I appreciate the replies. The day I bought the puts the ASX200 was just above 5200 and the day they were 14 points it was trading 5120.
 
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I only have historical implied vol data for MSCI Australia (EWA ETF), but I think it's a good proxy. In August implied vol for highly out of the money puts rose from 28% to 49%. That alone would result in a 3x return on those puts. Combined with the down move, you get to about 5x. I suspect the difference between the 5x and 7x can be explained by a difference in my proxy EWA and ASX200. For those interested, I charted the historical implied vol and ran scenario analysis on the option pricing with my tool at https://www.getvolatility.com (in beta but free)

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