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Nokia Corporation Message Board

  • vlad2vlad vlad2vlad Feb 13, 2013 6:23 PM Flag

    -- Options Expiry Phenomenon Explained

    Here's an old post of mine which explains why the stock price hugs a certain strike price and how and why Market Makers do it. If course institutions with lots if shares can also sell or go short to drop the stock price below a strike price so they don't have to deliver the shares if they sold covered calls but that's not why the pps always lands squarely so perfectly on the right price while dancing around the strike price all day long.

    Here is the copy and paste from the other board as you requested.

    2 weeks ago there were tons of BS theories about MM and how there has to be a real buyer for every seller. I explained then that MM have inventories and there is some manipulation but nothing like the Urban Myths going on on these boards.

    So here's another clear example how the options expiry when the stock pps gravitates towards a particular options strike price is NOT manipulation like most people Here are saying.

    Q. Is it true that options can make a stock "hug" the strike at expiration? I've heard that the reason this happens is that market makers want to make the most people lose the most money. Is that true?

    Some of the points people make are true. Others are urban myths. First, yes, it is true that options can make a stock "hug" the strike price at expiration. But the reason is that risk-free arbitrage is available -- not that market makers are trying to ruin your trade.

    Suppose XYZ stock is trading at 47 on the last day of trading in the April options. You own the April 45 calls, which are 1.90 bid, offered at 2.10 (parity is 2.00 -- the stock price of 47, minus the strike price of 45). If you sell your option at the bid to the market maker he can make a free 10 cents.

    From the market maker's point of view, this is what he does:

    Buy your April 45 call at 1.90
    Immediately exercise the call, to buy stock at 45
    Immediately sell the stock in the open market at 47 (this sale is short-exempt since the exercise instructions have already been issued).
    The market maker makes two points from buying the stock at 45 (step 2) and selling it at 47 (step 3). He's lost the 1.90 paid for the call (step 1), though, so his net profit is 0.10. He pays no commissions, so he will do this forever -- it's free money (riskless arbitrage) for him.

    If there is a large open interest in the April 45 calls, many retail call holders such as yourself will be selling these calls at a discount and the market maker will repeatedly execute his arbitrage.

    Note that in the course of the arbitrage, he sells stock! This repeated sale of stock -- especially if done in size in response to a large amount of sellers of April 45 calls -- will eventually force the stock down. However, once the stock gets down to the strike, 45, the "game" stops, for there is no longer a bid for the calls. Hence the stock is "pinned" to the strike from above.

    If the stock should fall below the strike, the entire process begins again -- only with put options. Say the stock drops to 44, and the April 45 puts are 0.90 bid. Retail holders of the April 45 puts will sell them to the market maker, who buys them, and buys stock, and exercises the put. Again, he makes the free 10 cents. Only in this case, he is buying stock and so the stock begins to rise back towards the strike, until the "game" stops once more. Eventually, the stock can't move either way because of the arbitrage potential in both the puts and the calls, and so it is "pinned" at the strike until expiration.

    So, yes, option expiration can make a stock go to a particular strike in the last couple of trading days and stay there, but it has nothing to do with market makers wanting to cheat you out of your options. It is strictly a function of risk-free arbitrage.

    Sentiment: Strong Buy

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    • I said yesterday we'd close 1 penny away from $4, although I think I said $4.01. $3.99 brings me back to the risk less arbitrage thread I started a couple says ago.

      The good news is that they slammed the pps to make it go under $4 so they wouldn't lose their shares after writing millions of covered calls. So next week we can have a fresh start not worrying about options manipulation.

      But like I said this morning when some were expecting 10% pop on the $5 strong buy upgrade out of Europe - we are not going past $4.20 until we get some kind of relevant news or a real big bank upgrades us, someone like Morgan Stanley or Goldman. I don't know what's taking so long, for me the sales are looking better then expected so I'm not sure what else they're cooking up.

      The hedge fund pukes robbed us of a massive advantage that leveled the field when they got the Facebook app to stop reporting MAU numbers. I don't think that was an accident. Of course they have access to info like that on a daily basis.

      It sure would be nice to get some kind of progress update or supply update for the 920. I mean, since Eflop is out there opening his gap, why not say something useful.

      Sentiment: Strong Buy

    • Thanks...Vlad for re-posting.

      Sentiment: Strong Buy

    • bemos@sbcglobal.net bemos Feb 13, 2013 6:25 PM Flag

      You got that yahoouser^^^^^^^

 
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