Are Bungee Bets Worth a Plunge?

The spread betting company IG Index recently introduced a new instrument: Bungee Bets. Their own site describes them as a way of profiting from market moves without the annoyance of being stopped out. If the market goes against you the bet remains open (if temporarily worthless), so that if later it comes back in your favour you can be smug, claim you were correct all along, and take a profit. But... well... isn't that what options do already? So I investigated the relationship between the new Bungee Bets and the Daily Options on IG.

Bungee Bets are quoted with a Floor or Ceiling. 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 essentially they work the same way as Call and Put Options respectively. If you think 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.
If you thought the market would rise and bought a Call Option at the money, if the market were to fall then your option would slowly decrease in value. If the market closed below your strike price then your option would close at zero. If you made the same play with a Bungee Bet rather than an option, what would happen? Well, if you bought a Bungee Bet with a Floor at the money, and the market went against you then you would slowly lose money. If the market were to close below your Floor then your bet would close at zero. So at the qualitative level, Bungee Bets and Daily Options seem to work in identical ways. But are they priced the same way?

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.

Let me give you two other examples just to show that this is not accidental. Rather than taking a punt at the market price you want a slightly cheaper contract so look at prices slightly out of the money, say at 6320. Now, the 6320 Call is priced at 10/13, so to buy it will cost you 13 points. As it is out of the money the value of the option is 13+20=33. Yes, you are only paying 13 points, but in order to close even the market must rise 33 points just to cover your deposit. Now the Bungee with a 6320 Floor is priced at 6329/35, so to buy this contract will cost you 6335-6320=15 points. As the market is currently at 6300 the Bungee Bet (just like the option) needs to make up 35 points just for you to break even. Note that the two mid-prices are 11.5 and 12 - identical save for a bit of noise. So yet again, the Options and Bungee Bets have virtually the same prices, with Options actually being marginally cheaper because of their tighter spreads.

The same thing happens for in-the-money contracts; I don't need to go through the maths of it! Well OK, I promised I would! A 6280 Call is priced at 29/33 with a mid-price of 31. A 6280 Floor is priced at 6308/14 with a mid-price of 31. To buy the Call will cost you 33 points, and to buy the Floor will cost you 34 points. Both are 20 points out of the money. Same difference!

So what have we discovered? That Bungee Bets are nothing more than Options in disguise, being priced in terms of their underlying market rather than merely the difference between the market and the contract strike price. They are the same thing, except Bungees wear a suit and tie whereas Options walk around naked. If anything, Options are a few points cheaper. So, the question strikes me,"Why has IG Index bothered to introduce a 'new' contract that is nothing more than an existing contract?" You may wish to ask IG that question. I rarely use IG's options as I think they are usually poor value compared to their Binary Bets (but that's another article). The only thing I can think of is that their options contracts are under-used and probably also misunderstood, so they decided to remarket them as Bungees. Well, we've seen through that one!

RM