Photo: Wikimedia Commons
Jacob Bunge at The Wall Street Journal reports that a trading blunder has cost BofA/Merrill nearly $10 million yesterday.The details are a bit technical and murky, but the gist is this: Yesterday was the day that the SPY ETF went ex-dividend, meaning it paid out a 78 cent dividend to owners, and thus would be expected to drop by 78 cents at the same time. There’s an options strategy that involves selling a bunch of borrowed call options right before this drop, and then buying them back afterwords… it’s essentially shorting a whole bunch of calls on this 78 cent drop. It’s evidently a controversial tactic to trade around dividends.
Apparently not all of the eligible options were properly exercised, thus causing a significant loss.
Trade Alert, which was the original source on the blunder thought the loss could even be as high as $20 million.
Here’s part of the email that was sent around:
SPY calls were candidates for early exercise ahead of today’s 78cent ex-dividend event for the widely held SP500 ETF. Total dividend proceeds available to the long-call holders was nearly $170million. As expected, call volume in SPY on Thursday was several times the normal level as nearly 6million contracts traded in the ‘dividend stripping’ strategy employed by a small number of traders. The trade involves buying and selling massive blocks of calls among counterparties, with each exercising the newedge long positions to effectively divert the un-exercised portion of open interest to their accounts. Normally we see about 8% of the eligible calls go unassigned in SPY, which would have yielded about $13million in profits to the traders involved. But this morning’s SPY open interest data shows an unusually large share, 24%, of the calls were not exercised , which works out to more than $35million for the traders who successfully implemented the trade. Sources on the floor are telling us that the unusually low exercise percentage in SPY yesterday was the result of a mistake or clearing error on the part of one of the pros involved in the dividend trade, suggesting this seemingly ‘riskless’ operational arbitrage was anything but safe, and one trader may be looking at a 20-something million dollar loss today.
The details differ. WSJ is saying $10 million. Trade Alert thought it was more like $20 million associated with a single trader. Either way, something happened so that a “riskless” approach to arbitraging dividend day went awry.
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