Strange S&P options volume may be box spread

By Doris Frankel

CHICAGO, Aug 31 (Reuters) - Unusual volume in options on the Standard & Poor's 500 index .SPX with strike prices more than 50 percent below the index's current level has tongues wagging in the option markets.

But analysts and traders say the options activity is more likely evidence of an arbitrage trading strategy than a sinister bet on a big sell-off in U.S. stocks.

The huge open interest in the SPX 700 calls and puts was likely part of a so-called "box trade," a strategy typically used by professional traders as a hedge transaction with no risk.

Several financial Web sites this week, including the Street.com, were full of chatter about the heavy open interest in the SPX 700 put and call contracts.

Open interest is the number of contracts on a certain strike price that are in still existence, which are not yet exercised or closed.

The blogs saw the unusual open interest volume in these contracts as someone betting on a market catastrophe, and predicting that the S&P 500 would drop 50 percent in four weeks.

A seasoned options market strategist, though, saw the whole thing differently.

"Some of these blog letters that think the huge open interest in the SPX 700 calls and puts is a terrorist play is nothing more than a financial transaction of market makers on the floor of the options exchanges," said Michael Schwartz, chief options strategist at Oppenheimer & Co. Inc.

Schwartz was referring to a box trade. It happens all the time.

"It is a non-event," he said.

As of Aug. 30, the open interest on the September 700 put, which allows investors to sell the S&P index at 700 stood at 119,541 contracts, while the number of open contracts in the September SPX 700 call contract, giving the right to buy the index at 700, was at 64,730 lots.

DON'T BOX ME IN

The box spread is essentially an arbitrage strategy where professional traders such as market makers borrow or lend money. They would borrow money to finance their other stock and option trading positions or they would lend money if their trading activities generated cash.

This hedge transaction entails a call spread and a put spread -- or a four-sided options spread that involves a long call and short put at one strike price, as well as a short call and long put at another strike price.

"It is not uncommon to see large box trades on the indexes like the S&P 500 index," said Alex Mendoza, an instructor at options education firm Optionetics.