Monday, December 14, 2009

Moody's (MCO) - House Bill and a Risk Reversal

MCO is trading ~26.62. You can see the LIVEVOL™ Pro Summary below.

There is a good deal of uncertainty in the credit rating agencies as the government contemplates greater regulation over them. The Credit Rating Agency Reform Bill was recently passed (final approval expected Q2 2010). The link to the bill is available if you CLICK HERE . Two highlights are:

- "credit rating agencies are of national importance"

- "the Commission has indicated that it needs statutory authority to oversee the credit rating industry."

Looking at the biggest trades of the day you can see a developing bet. Click the image below to enlarge.

Looking at the Options Tab makes the trade much clearer. Note the size versus the OI. Click the image to enlarge.

This is opening: The Jan 2011 17.5/35 risk reversal was sold 8500 times @ 0.10 (Sell Calls @ 2.05, buy Puts for 1.95) delta neutral against 26.75 stock. The pay-off diagram for the strategy (with long 425k stock) is below assuming 50 delta (16 in the puts, 34 in the calls). Click the chart to enlarge it.

This is essentially selling a Jan 2011 35 straddle and buying baby puts. The bet is the stock goes to 35 (goes to the short strike) with protection to the bottom.

Selling the Jan 2011 35 straddle calculations:
Sell Calls @ 2.05.
Buy Stock 26.75.
Synthetic puts = parity + 2.05 - cost of carry
= (35-26.75) + 2.05 -~0.15
= 8.10

So the short straddle receives: 2.05 + 8.10 = 10.15

Note that selling calls gets short vega (8500 x -.104) and buying puts gets long vega (8500 x .067) for a net short vega position.

The bet makes ($.104 -$.067)*8500*100 = $31,450 for every vol point drop.

For what it's worth, reports are being sent out that this bill will reduce the uncertainty in these stocks moving forward. That is a vol decreasing event and this trade gets short a little vega.

This is an upside bet (even though it is delta neutral) and short volatility.

For LIVEVOL™ Pro users, I found MCO from the new OTM Puts scan added today (image below - click to enlarge).

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