A big bet on a seemingly random small cap or a simple misunderstanding thanks to the complex math of options?
(Bloomberg) — A big bet on a seemingly random small cap or a simple misunderstanding thanks to the complex math of options?
In the world of derivatives trading, it can be hard for Wall Street to tell the difference — a lesson likely playing out in a tiny healthcare company this week.
On Tuesday a trader, or a group of traders, purchased half a million call options on Bright Health Group, Inc., lavishing $5 million on the wager.
Such a large bet on a snoozy microcap is unusual, since options rarely trade on the company. And at first blush the price paid — between five and 10 cents each, targeting shares at $2.50 a piece — seems a no-brainer given the stock currently trades around $14. Yet a recent reverse stock split approved in May — sparking a price adjustment for options contracts — changes everything.
The maneuver gave each shareholder “the right to receive 0.0125 (New) Bright Health Group, Inc. Common Shares,” according to a memo from the Options Clearing Corporation, which provides clearing and settlement services for derivatives. The agreement also provided compensation — or cash in lieu — calculated as a fraction of BHG shares.
All this created a logistical headache. Functionally, it meant that the options price had to be adjusted. The option symbol changed to BHG1 from BHG and the cash in lieu amount was determined to be $2.26 per BHG1 contract.
That puts the price of the (new) Bright Health Group, or BHG1, contract at around $0.16. In sum, the buyer(s) spent close to $5 million for the right to buy an asset if it rallies at least 1,462% to above $2.50 by the Nov. 17 expiration date.
One of two things is happening, according to Steve Sosnick, chief strategist at Interactive Brokers. The trader is either incredibly bullish on the company — or simply mistaken.
In the case of the second scenario, it’s hard to know what the trader may have thought exactly. It’s possible they might have misunderstood the effective price of BHG1 to begin with — perhaps thinking that it traded close to the cash in lieu amount of $2.26. Had that been the case, a bet that the price would increase to $2.50 would not be an outlandish expectation.
Or maybe the individual thought that the underlying option traded for $16, instead of $0.16, thus assuming that they were buying a call option already very, very in-the-money. Hence, free cash.
But a no-brainer trade it is not.
“The buyer might have thought he was getting something for free, and the seller knows that they’re essentially worth much less,” Sosnick said. “When trades look too good to be true, they usually are.”
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