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Weekly options with a 30% correction. The single greatest transfer of wealth in history.

I came across a fintwit post today that showed monthly options are at an ATH average of $580bn a month. The majority of them concentrated in weekly expirations.

It got me thinking about how much money is needed to payout the shorts should there be a week when the market decides to take another 20-30% crash.

Quick maths, with tons of assumptions:

Let’s say there’s $250bn in weekly puts.
Let’s say they’re all bought ATM.
Let’s say the market crashes quickly and results in back to back limit downs so most people aren’t even able to sell and the majority of them are held to pretty decent gains.

If the markets drop 30% from say $360 (QQQ) that’s $252. A weekly ATM put bought on Monday probably costs about $2 ($200). Assuming you held to full drop – that’s 108 intrinsic value and $106 profit. Or $10,600. Or 5,300% gain per contract.
This is just considering ATM puts. There’s a good % that would be a few strokes lower and return something like 10,000-15,000%. In a week.

Now let’s take those returns and apply them to the $250bn in puts floating around each month.

$250bn + 6,000% gain = $15 trillion dollars.

Just in ATM weeklies!

(Yes this is napkin math and wildly speculative and blah blah – I’m illustrating a point).

When you consider all the short positions, long term dates puts etc, the “cost” of a 30% weekly correction is probably in the 100+ TRILLION $ transfer of wealth to investors who are short American markets.

There’s SO much money waiting to be paid out to shorts that I honestly don’t think the governments could possibly allow it because it’s such a large chunk of money that it would completely distort the entire global economy.

The market is never going to go UP 30% in a week. It’s too large and there’s no catalyst for such a thing to ever happen.
So they can “afford” to payout calls overtime as they have slower, but steadier gains.
However, I honestly think the government (namely the Fed) sees how much money is at stake if they allow the market to correct and I don’t think they can foot the bill.

Especially when you consider the lost 30% in market cap – it would be the single greatest wealth transfer in history.

Tl;dr – there so much $ in leveraged short positions that a 20-30% crash in a week would be the largest transfer of wealth in history and possibly cost over $100 trillion in pay outs to bears.

What do you think?

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14 Comments

  1. Your assumptions don’t hold.

    There are a significant number of PUTS that are deep OTM that won’t hit (I.e the apes), ditto there are a lot of deep ITM options that trade like stocks and don’t generate those 6500%+ returns.

    Depending on the stocks, the option are priced for a level of volatility. (would be interesting to know how the money is spread between between high iv vs low iv options)

    The people selling the puts (I.e. market makers like citadel) also are the ones selling the calls, so they are hedged in premiums as those weekly calls will expire worthless.

    They will also be shorting the shares on the put sides based on the delta to cover their positions. The ‘shorts’ you mention are often also the options sellers.

  2. Just pointing it out because it caught my eye, you said it is “impossible the market goes up 30% in a week”.

    Now that would be the real black swan event but the possibility of a meltup of the market is there, when hyperinflation occurs the market can “meltup” like the venezuelan stock market. Just a thought, rather unlikely to happen, but that’s the balance act of the fed being between a rock and a hard place with their actions

  3. If those 250B in weekly puts were mostly all on SPY, then yes an overall market drop of 30% would be captured by those puts and there would be little that MM could do to avert a meltdown. Thats probably not the put allocation situation right now.

  4. I really don’t agree with your post in any way. Not only are your assumptions way off, but for the stock market to drop 30% we would need a black swan event even bigger than corona.

    Rates have been low for the past decade. They really are not going to cause a crash of 30% unless the fed raises rates rapidly. Which they have not done in the past 5 decades. Nor have they indicated that’s what they intend to do.

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