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I often read on twitter that institutions will manipulate the price of stock x because it's options expiration day. By manipulating the price of the stock below the strike price, it's my understanding that the options would expire worthless and the counterparty would profit.

Is such a thing illegal? if one buys options, how can they protect themselves? Does this typically only occur in low volume stocks?

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Institutions and market makers tend to try and stay delta neutral, meaning that for every options contract they buy or write, they buy or sell the equivalent underlying asset.

This, as a theory, is called max pain, which is more of an observation of this behavior by retail investors. This as a reality is called delta hedging done by market makers and institutional investors. The phenomenom is that many times a stock gets pinned to a very even number at a particular price on options expiration days (like 500.01 or 499.99 by closing bell).

At options expiration dates, many options contracts are being closed (instutitions and market makers are typically on the other side of those trades, to keep liquidity), so for every one standard 100 share contract the market maker wrote, they bought 100 shares of the underlying asset, to remain delta neutral. When the contract closes (or get rid of the option) they sell that 100 shares of the underlying asset.

At mass volume of options traded, this would cause noticeable downward pressure, similarly for other trades it would cause upward pressure as institutions close their short positions against options they had bought.

The result is a pinned stock right above or below an expiration that previously had a lot of open interest.

This tends to happen in more liquid stocks, than less liquid ones, to answer that question. As they have more options series and more strike prices.

No, this would not be illegal, in the US attempting to "mark the close" is supposedly prohibited but this wouldn't count as it, the effect of derivatives on stock prices is far beyond the SEC's current enforcement regime :) although an active area of research

  • Thanks. If MMs and institutions are delta neutral, then their only profit can come from bid-ask spread, correct? Is it enough to be in business? – Victor123 Oct 14 '14 at 16:33
  • their profit comes from rebates, spread, not having any commissions and selling data. they use a lot of leverage to take more orders and more volume. As long as they never ever mess up and wind on a wrong side of the market, they are fine. But occasionally you hear about a market maker messing up (Knight, back in 2012) – CQM Oct 14 '14 at 16:35
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If the strike price closest to the underlying has high open interest, the options expiration is a bigger event. For instance: stock is at $20 w/ average volume of 100,000 shares per day. 20 strike has 1000 open interest. In this example the stock will "most likely" pin at 20 if we were expiring tomorrow.

As u prob know, long calls at 19.90 close, turn into stock....long puts at 20.10 turn into short stock. Option pros (high % of volume) dont want to be short or long after expiration. Long call holders will sell above 20 to hedge, and long put holders will buy below 20. 1000 open interest is equivalent to 100,000 shares. That's the same amount as the average volume. Stock can't really move until after expiration. If I am long 10 $20 calls, and short 1000 shares I am flat going into expiration.....unless the stock gets smoked and now I am synthetically long a put....Short stock + long call= Long Put

Then watch out cause it was artificially locked down.

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