You Can't Trade in a Vacuum

One of the common mistakes many traders make when looking at options is to try to view them in a vacuum. Throughout the day, we will see extremely large blocks of calls and puts trade in equities, ETFs and indexes. But if a trader buys puts in the S&P 500, does that mean the trader is bearish and thinks there is impending doom in the S&P? The answer is no, almost no trades in the SPX go up by themselves. A trader buying puts is almost always trading it against something, often it's against a portfolio of equities, or it could be against a bond portfolio.

Here is an example of an equity put trade that went up in a vacuum but had a huge trade against it on the other side. In 2007, I was a market maker in old General Motors (GM) . At the time, GM was trading at $26 to $30 a share, but was carrying a large amount of debt. It was in the process of unwinding GMAC in an attempt to handle some debt issues. The stock was a bit hard to borrow and the debt was junk at the time. During that time, there was massive demand for the GM January 2009 $2.50, $5 and $10 puts; puts that were between 60% and 90% out of the money. Traders were buying hundreds of thousands of these puts....493 more words left in this article. To read them, just click below and try Real Money FREE for 14 days.

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