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Shifty Market Not for the Faint of Heart

An overseas trader sends the put/call ratio skyward with a bullish bet on the QQQs.

After some early morning gyrations, major stock proxies were drifting lower Thursday afternoon, struggling to reconcile mixed retail sales, technical breakdowns and recoveries, as well as concerns about geopolitics.

As of 3:28 p.m. EST, the

Dow Jones Industrial Average

was down 0.7% to 7932.11 after having traded as high as 7991.96 and as low as 7892.01. The

S&P 500

was off 0.6% to 838.40 vs. its intraday high of 844.26 and low of 833.26.

The S&P's break of 840 was considered technically significant, as it marked the lower end of its recent trading range, but as the average held around those levels and didn't fall further, short-sellers were compelled to cover.


Nasdaq Composite

was up fractionally to 1301.96 vs. its earlier high of 1310.51 and low of 1292.71. The Nasdaq 100 was lately up 0.5% to 973.97 after having traded as low as 961.50. As with the S&P and 840, some traders were watching to see if the NDX will soon test the lower end of its trading range, at about 950 to 955.

Most long-term investors remained cowed by the overriding bear market and wary of taking positions ahead of Hans Blix's Feb. 14 address before the U.N. (the next big event on that docket). As a result, the market had become even more the playground of trader types.

Something Amiss in the Put/Call

Amid that very trader-oriented market, much of the focus midday Thursday was about a sharp spike in the Chicago Board Options Exchange (CBOE) put/call ratio at about 11 a.m. EST. The put/call ratio rose to as high as 2.55 as equity put-buying went from around 84,100 contracts at 10:30 a.m. to more than 310,000 one hour later.

Put contracts give the buyer the right to sell a stock in the future at a lower price and are a classic defensive or bearish mechanism. Call options, conversely, are a means to make a bullish bet. On the surface, such a leap in the put/call ratio would be an indication of a sharp increase in fear among market participants.

But things aren't always what they seem, especially on Wall Street, especially these days.

For the third time this week, the put/call ratio was skewed by a large spread trade involving long-term puts in the

Nasdaq 100 Trust

(QQQ) - Get Free Report

, traders said. An investor bought a large chunk of January 2005 45 puts and sold an equal number of the January 2005 55 puts.

Specifically, 73,000 contracts of each put series were traded, making them the most active of the session, according to the CBOE, and producing a sharp increase in overall put activity. (The fund manager was also actively trading the January 2005 45 put QQQ LEAPS -- another form of option -- Thursday, but not the 55 puts.)

"If you take out the quantities of these trades, the put call/ratio is far from being" 2.55, observed one options trader.

Jon Najarian, president of Mercury Trading, one of the largest market makers at the CBOE, dubbed the put spread trades "outlandish and huge," resulting in "the most extraordinary index put volume I've ever seen" The trades were rumored to be done by a British-based hedge fund, although he couldn't specify which one.

"The manager wanted to buy puts and buy the underlying QQQ, a trade often referred to as a 'married put,'" whereby the put serves as downside protection for the long position, Najarian explained.

"However, the fund manager didn't get the price he was looking for, so instead of buying the puts and buying the QQQs, he sold a 'put spread,'" Najarian said, describing the simultaneous purchase of one put and sale of another at a higher strike price.

If the short side of the trade -- the sale of the 55 puts -- is exercised by the buyer, the fund manager will be left with his long 45 puts and a long position in the QQQs, "which puts him right into the married put trade he wanted in the first place," Najarian continued. Because of the way the QQQ options settle, the manager will get the underlying security -- in this case the QQQ -- if his sale of the 55 puts is exercised by the buyer.

"Traders say this trade has been done some 300,000 times," the market maker noted, estimating "this one bullish fund manager has placed a very large bet, somewhere between $250 million and $750 million." (300,000 contracts equals 30 million shares of the roughly $24 index.)

The Butler Did It

In terms of motive, Najarian noted that a married put has the same risk/reward as an outright call purchase. But the overseas manager might have not wanted to buy the calls because of tax issues, a desire to "churn" the portfolio, or other considerations.

Also, he recalled that earlier this week there was a sharp rise in the S&P 500 e-mini futures contract at the Chicago Mercantile Exchange (CME) at 4:07 p.m. EST Tuesday, on the eve of


(CSCO) - Get Free Report

earnings report. The spike was later attributed to a "confluence of events" that triggered a series of buy-stop orders, and trades above 860 were canceled or "busted" soon thereafter, according to a CME spokeswoman.

The offshore hedge fund manager might have been part of that trade, or merely witnessed it and become more bullish, Najarian theorized. A similar spike in U.S. stocks could occur if "something favorable happens" regarding Saddam Hussein, i.e., "some capital that's flown the U.S. might return." (Rumors of Saddam's death apparently contributed to the spike in the e-mini futures.)

Finally, conspiracy theorists will note these bullish QQQ trades are reportedly coming out of England, where the Bank of England unexpectedly lowered rates 25 basis points to 3.75% Thursday, its first ease since November 2001.

Presumably, lower rates overseas would help the dollar, as it reduces the yield spread between the pound-sterling and the greenback. A stronger dollar would likely aid U.S. stocks, and someone with advance knowledge (or suspicion) of the rate cut might make an accordingly bullish bet on U.S. equities.

Najarian didn't dismiss this theory entirely, but said there are far more direct ways for a hedge fund to bet on currencies and interest rate movements. Furthermore, the dollar traded lower Thursday after brief early gains as the European Central Bank did not follow the Bank of England's lead, leaving rates in the Eurozone unchanged. The U.S. Dollar Index was lately off 0.23, to 99.42.

Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.