Amidst the rally on Wall Street yesterday, let us not overlook the fact that General Electric (NYSE: GE, Stock Forum) hit new multi-year lows of $11.88 before getting off the matt and rallying into positive territory. It is worth noting that the 5 strike puts in Feb and March were active yesterday, in ways all too familiar to other meltdowns.
The Feb 5 strike puts traded over 32,000 times versus open interest of 22,400. The puts were trading for around 12 cents with the stock at $13. The March 5 puts were also very active with volume of over 59,000 versus open interest of 24,000. Both of these puts are trading more on the buy side than the sell side, as evidenced by the fact that the price of the puts increased slightly, despite the small rally in the shares. Stock up, puts up, that can only mean more buyers than sellers.
What is interesting about these puts, however, is not the volume. That kind of volume in GE options occurs quite frequently because it is such a widely held stock. What is interesting, however, is that this 5 strike is a strike that is typically used when fears of bankruptcy are running rampant. Think about it. These puts are over 50% out of the money. Throughout 2008 we saw similar activity in LEH, BSC, FNM, FRE, AIG, and we all know what happened there.
These puts are also an example of how sometimes implied volatility ceases to be relevant for an option. What we mean by this is that the implied volatility is so high that it suggests a distribution pattern that no longer is log normal, which is what volatility math relies on. Instead, the options become like lottery tickets. Take the March 5 puts for example. At a price of 20 cents versus a stock price of $13, the implied volatility is 166. Compare that to the implied volatility of the March 14 strike, which is 72, and you can see what I mean. The buyers of the March 5 puts are not concerned that it is a 166 volatility. They are more interested in the pay off. They are paying 20 cents for a lottery ticket that could be worth $5 if the stock goes to zero. Risk 20 cents to make $4.80, that is like a lottery ticket that pays 24 to one odds.
Put buys like this do not mean that investors should run out and sell GE right away. But it is worth noting that this is the same type of activity that we have seen all throughout the financial crisis. As one stock after another has met an untimely end, big activity in the lottery ticket like puts preceded the end times.