The S&P 500 is having a disastrous December.
The benchmark index has slumped 9 percent over the past three weeks, its biggest loss for the final month of a year since 1931. This week alone it has tumbled nearly 4 percent and touched its lowest levels of the year.
"Where I saw some interesting activity was a big purchase of the February 240-puts. Somebody paid $5 for just under 42,000 of those," Khouw said on Wednesday. Since each options contract accounts for 100 shares, those puts equate to around $21 million in premium spent that the SPY S&P 500 ETF would fall below $235 by February expiration.
"Likely what's going on here is that somebody with at least a billon dollars' worth of S&P 500 exposure, concerned about further declines in the market, decided to spend a little bit over 2 percent of their total holdings to hedge against further declines," he added.
That call suggests another 6 percent downside from current levels, says Khouw. Such a drop would take the S&P 500 down to April 2017 lows.
Khouw says bearish options trading has spiked recently as the market continues its fall. On Wednesday, for example, the SPY S&P 500 ETF had 3.3 million put contracts, above the roughly 2 million average put volume.
The SPY ETF was lower again on Thursday and tracking for its third negative week in a row. It has fallen 6 percent this year.