Boneheaded Dividend Bungle Costs Trader $20M

Boneheaded Dividend Bungle Costs Trader $20M
On Friday, 2.4 million in-the-money SPY calls were candidates for early exercise ahead of today's $.78 ex-dividend event for the widely held SP500 ETF. Total dividend proceeds available to the long-call holders was nearly $170 million. As expected, call volume in SPY on Thursday was several times the normal level as nearly 6 million 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 new 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 $13 million 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 $35 million 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.

About Henry Schwartz

Henry Schwartz has traded derivatives on US and European exchanges for nearly 20 years. His experience includes market-making and institutional trading at the Hull Group, Salomon Brothers, Bear Stearns and most recently Banc of America Securities, where he led the electronic market-making project coincident with the launch of the ISE. His current work involves real-time stream analysis of options market activity for a number of leading institutional sell-side firms.