The spread betting company IG Index has recently introduced a new product: Bungee Bets which IG describe as a way to profit from market moves without the hurdle of being stopped out if the market moves against you. In the circumstance that the market does move against you (just for the day, unfortunately) the bet will remain open even if temporarily worthless so that if at a later time the market turns in your favour you can still make a profit...
Bungee bets come with a pre-defined 'Floor' or 'Ceiling' meaning. A Floor is a level below which the bet will not fall, and a Ceiling is a level above which it will not rise. So practically they work in the same way as Call and Put Options respectively. If you believe the market is going up you could either buy a Call Option or a Bungee Bet with a Floor If you think the market is going down you would buy either a Put Option or a Bungee Bet with a Ceiling.
The Floor or Ceiling work very much like a stop level as it guarantees that you cannot lose more than a pre-determined amount on your position.
The key difference here when compared to a normal stop is that the Bungee bet will remain open if the underlying market breaches the Floor or Ceiling level. So if the underlying market swings back to your favour later in the day you can still make a profit. This is especially useful in volatile markets where sudden dips and blips can interrupt the general trend of the market.
Let's take an example: 'Buying' a FTSE 100 Daily Bungee -:
The FTSE 100 Index is hovering at around the 6025 level and you believe it is going to end up by the end of the day.
IG Index are quoting 6030 - 6034 on their FTSE 100 Daily Bungee: Floor 6015.
You decide to bet £510/point that the Bungee bet price will rise above IG's buy price of 6034. You know that your maximum risk is capped at 19 points, since the Floor level is fixed at 6015. (6034 - 6015) = 19). Note: recall that you cannot sell a Bungee with a Floor; if you wish to go short you would sell a Bungee with a Ceiling.
Within hours the FTSE index rises and with it your Bungee: by 12pm the Bungee price is quoting at 6080 - 6082. At this point you could sell out for a 46-point (£5460) gain but you decide to ride the trend and let your profits run.
However, unfortunately the market turns against you and the FTSE is trading down at 6005. Your maximum liability is safely frozen at the pre-determined Floor as the Bungee price now stands at 6015 - 6019. Should the index recover you could come back into profit; otherwise the maximum you could lose would be 19 points (£5190).
The Dow Jones opens with a strong start and the FTSE re-bounds following Wall Street. Your Bungee is re-activated - and, in this scenario, you end up ahead.
Your position expires at the market close of 6110.
Opening level 6034
Closing level 6088
Profit: 54 x £510 per point = £540.
At first glance Bungee bets appear to have clear advantages over normal trades. But nothing in life is free and Bungee bets come at a price - they do not come cheap. Bungees areare equivalent to portfolio insurance, i.e. long position plus put option or short position plus call option.
Surely a long bungee is exactly the same as buying a daily FTSE call with the strike equal to the bungee 'floor', and a short bungee just a long naked put. Sounds to me like a way of selling options to people who don't know what an option is, or are scared of them.
This is what 'Rycharde Manne' had to say about them -:
'If you look at a Bungee Bet at or around the current market price you will see that the 'market price' quoted for that bet is very different to the real underlying market. I took a snapshot yesterday when the FTSE was bang on 6300 to make the numbers nice and easy.'
'Let us assume you think the market will rise. You start by looking at the FTSE Bungee Bets with a Floor below which your bet cannot fall. The 6300 Floor is priced at 6318/6324. Immediately you can see that the Bungee 'market price' is already way above the underlying market price. If you were to buy this contract then your liability would be the Buy price minus the Floor, in this case 6324-6300=24 points. Also note that the spread is 6 points and the mid-price is 6321, or 21 points. Now what about the equivalent option?'
'Look at the FTSE Daily Options and find the 6300 Call. This was priced at 19/22, meaning that to Buy this option would cost you 22 points, with a mid-price of 20.5. Note that the option spread at this price is just 3 points compared to the Bungee's 6 point spread. Apart from these small differences, your liability - how much you actually deposit from your account - is almost the same. If anything, Bungees are slightly worse in terms of spread and hence the amount you need to make up just to get even.'
The drawback with the Bungee bet is that you have to open both the spot and option position simultaneously, whereas the same protection will be cheaper to buy later, using options, than at position entry - assuming the underlying goes your way initially.
If the underlying doesn't go your way initially, you were simply wrong and an ordinary stop loss would be cheaper protection.
The benefit of the Bungee bet is that both spot and option get closed out at expiry, so the bet makes sense if you intend to leave the position open until expiry - for example if you will be unavailable to close the position manually. Then, again, a limit order and a wider stop would do a good job as well.
If you use a stop loss level which is very close, say 40 points away on the Dow Jones, you will pay a higher premium over the current price which reduces the scope of using a Bungee Bet. On the other hand if you use a bigger stop loss - say 100 points, the premium payable over the current market price is relatively low, say 10 points depending on how much of the trading session has elapsed.
Finally, the insurance protection will be cheaper the later in the day you enter the position, as there will be less time premium to pay in the option.
Hint: Use bungee bets when you are convinced the market will rise but there is a potentially threatening announcement like inflation numbers or Fed action looming. Useful also when top picking or bottom-fishing.
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