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If currency markets don''t behave, we''ll rig them, Japan''s finance minister says
Anyone with access to enough money can
do this kind of thing every day to fleece
the smaller participants in the market.
* * *
University of Illinois Study
Casts Shadow on Options Trading
By David Roeder
Chicago Sun-Times
Tuesday, October 18, 2005
http://www.suntimes.com/output/business/cst-fin-cboe18.html
How honest is the stock-options market? Newly published research
from academics at the University of Illinois said there are times
big trading firms manipulate the market to their advantage.
The manipulation, which is illegal, takes place in the final days
before options expire within a given month, said the study published
in the October issue of the Journal of Financial Economics.
The study is the work of finance professor Neil Pearson, associate
professor Allen Poteshman, and Ph.D. student Sophie Xiaoyan Ni. They
based their findings on a mathematical analysis of data from the
Chicago Board Options Exchange that covered trading from 1996
through 2002.
They said big investment banks that trade for both themselves and
customer accounts often steer the markets by selling options on
specific stocks a few days before expiration. Then they trade the
stock itself so the price finishes "out of the money' at
expiration, meaning the options they sold won't be exercised, the
researchers concluded.
That allows the firms to keep the premiums they collected, which
represent the cost of the options they sold.
"This is an extremely profitable business" for the investment
banks, Pearson said. He said the practice hurts some individual
traders but that more likely victims are market making firms that
work the CBOE floor.
A CBOE spokesman had no immediate comment. It was the leading market
for stock options during the years the study covered.
The researchers also cited benign factors that contributed to stock-
market disruptions on option expiration days. Options, which are
contracts to buy or sell a stock at a given price, expire on the
third Friday of each month, and traders have long noted that the day
brings heavy volatility.
Overall, the value of stocks that have options attached to them
changes an average of $9.1 billion on expiration day, the report
said.
The researchers could not say which investment banks engaged in
manipulation because the data they saw included only general coding
about the sources of the trades. But their information has been sent
to the Securities and Exchange Commission, which could follow up
with more scrutiny.
Pearson and Poteshman said nothing in their work indicates options
trading is inherently corrupt. But they said they found strong
evidence that options trading influences stock prices, an issue
that's been a long-term SEC concern.
Although both professors specialize in options research, they said
they don't trade the contracts.
"Independent of this study, I don't think it makes much sense for
retail investors to trade options," Pearson said, acknowledging
that his view would earn him enemies on LaSalle Street.
Poteshman said options could be useful, but commented, "I would
probably think twice before buying an option that expires in a few
days."
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