hi all, I am currently doing Ethics from schweser notes and stuck with the following. I am really having a bad time understanding how options, portfolio mgmt work… This is the eg… from Application of standard VI (B) Priorty of transactions … A brokerage’s insurance analyst, D.W., makes a closed circuit report to her firm’s branches around the country. During broadcast, she includes negative comment abt a co. within the industry. The following day, D.W.'s report is printed and distributes to the sales force and customers. The report recommends investors to take profits by selling co’s stock. Several minutes after broadcast, Ellen Riley, head of the firm’s trading dept, closes out a long call option position in the stock. Shortly thereafter, Riley establishes a sizable “put” option position in the stock. Riley claims she took this action to facilitate anticipated sales by institutional clients. This is in violation of std VI (B)… as by taking action before the report was disseminated, Riley’s firm could have depressed the price of the calls and increased the price of the puts. The firm could have avoided a conflict of interest if it had waited to trade for its own a/c until its clients had an opportunity to receive and assimilate W’s recommendation. i am trying to understand what happened in this case : 1) (it may seems real dumb) is closure of call option same as exercising call option? by establishing a put option, how Riley’s will get benefitted? 2) how Riley’s firm could have depressed the price of the calls and increased the price of the puts? 3) how clients have affected by Riley’s action? can anybody pl. suggest me a good site abt options? appreciate your help… - MH
mhnatu Wrote: ------------------------------------------------------- > hi all, > I am currently doing Ethics from schweser notes > and stuck with the following. I am really having a > bad time understanding how options, portfolio mgmt > work… > > This is the eg… from Application of standard VI > (B) Priorty of transactions … > > A brokerage’s insurance analyst, D.W., makes a > closed circuit report to her firm’s branches > around the country. During broadcast, she includes > negative comment abt a co. within the industry. > The following day, D.W.'s report is printed and > distributes to the sales force and customers. The > report recommends investors to take profits by > selling co’s stock. Several minutes after > broadcast, Ellen Riley, head of the firm’s trading > dept, closes out a long call option position in > the stock. Shortly thereafter, Riley establishes a > sizable “put” option position in the stock. Riley > claims she took this action to facilitate > anticipated sales by institutional clients. > > This is in violation of std VI (B)… as by > taking action before the report was disseminated, > Riley’s firm could have depressed the price of the > calls and increased the price of the puts. The > firm could have avoided a conflict of interest if > it had waited to trade for its own a/c until its > clients had an opportunity to receive and > assimilate W’s recommendation. > > i am trying to understand what happened in this > case : > > 1) (it may seems real dumb) is closure of call > option same as exercising call option? by > establishing a put option, how Riley’s will get > benefitted? > Possibly, but not likely and almost surely would be a stupid move. Closing the position simply means selling the call option to someone else. > 2) how Riley’s firm could have depressed the price > of the calls and increased the price of the puts? > Riley’s firms report was unfavorable to the stock, so the report and the subsequent selling by Riley’s customers could cause the stock price to drop. If the stock price drops, puts with a fixed strike increase in value while calls fall in value. Riley’s firm was essentially front-running their own clients. Very naughty and a problem beyond CFAI’s ethics policies. > > 3) how clients have affected by Riley’s action? > Selling calls and buying puts is bearish and puts downward pressure on the stock. This is essentially put-call parity at work - if the strikes are the same you just went short a synthetic futures contract. Obviously the stock price needs to stay in line or there is arbitrage. > can anybody pl. suggest me a good site abt > options? Schweser? > > appreciate your help… > - MH
mhnatu, the problem here is that Ellen Riley is front-running the firm’s clients, which as you stated, is a violation of Standard VI(B): Priority of Transactions. The firm is recommending that its clients sell their shares, but adequate time hasn’t passed since the report was disseminated for this to actually take place. Assuming clients actually follow the report’s recommendation, the company’s share price will decrease, causing outstanding call options to decrease in value and outstanding put options to increase in value. Specific responses to your questions: 1) They mean selling the call option 2) Selling calls would depress their price, buying puts would increase their price 3) [see JoeyD’s post] I hope this helps. Edit(1): JoeyD beat me to the punch, but he passed up another opportunity to discuss squidsicles, so tastey. Edit(2): deleted explanation of negative impact for clients. Joey’s explanation is better.
thanks Joey and hiredguns1… I Got it !!!
Closing an option means selling, not exercising. Establishing a put position is ambiguously worded. They mean establishing a “long” put position, which means buying puts, which is a bearish maneuver as Joey mentioned.