Suppose you have a client who wants to sell a large position in a stock AND sell the long puts on it as well. The amount of stock to be sold is significant with respect to the daily volume and will likey drive down the price. The client insisted that this trade has to be completed today.
Note that you don’t have access to crossing networks, dark pools, etc. so you must make this trade directly via the exchange.
So you sell your client’s shares throughout the day and the stock drops 5%, doing your best not to drive the price down more than necessary. AFTER you’ve already finished executing the shares you sell the long puts which have increased in priced due to your selling of the shares driving down the price.
Have you committed a violation here (i.e. market manipulation.) ? You didn’t directly and forcefully try to manipulate prices but you already knew that a mandatory order will likely drive down the underlying price so you stratetically sell the underlying first before selling the puts (also a mandatory order.)
The question is flawed. It assumes you can make money like this but you can’t. It’s like saying you have 2 trading accounts, one with a big short position in a stock and the other accont in a big long position in the same stock. Are you manipulating the markets by trying to make money by selling the long position first in order to make a motza on the short position?
No, you are long the underlying stock and long puts. You sell the underlying stock first which depresses the price because of the large volume being sold. THEN you sell the puts after selling the stock.
Market manipulation is a practice that distorts prices or artificially inflates trading volume with the intent to mislead market participants. Unless his intent is to mislead market participants (and there’s nothing to suggest that it is), then it’s not market manipulation.
The intent is to liquidate the portfolio holdings at the request of the client. You should execute this in the most efficient way possible to reduce transaction costs. If you believe you will reduce transaction costs by selling one before the other then I believe that is ethical. (Never the less you I’m guessing you still lose money either way since the put options have a delta less than 1, most likely, and its probably not perfectly delta hedged).
The key point here is that the client is forcing you to liquidate the holdings and the intent is raising cash and reducing transaction costs.
If the intent was to some how earn a net profit by selling a combination of puts and long stock, when you aren’t being forced, then I believe it would be considered market manipulation.
IIRC, there was a question similar to this on a recent AM section or CFAI PM mock (don’t remember which, I’ve done so many) but basically if you’re doing your job and legitimately trading, it isn’t market manipulation even if you wind up moving the market as a result of your trading.
I got what you are trying to do but my response is the same. It’s equivalent to being long stock and short stock, and selling the long position first then covering the short position and hoping to make money this way. It doesn’t work.
You are long puts (i.e. you are short deltas, i.e. equivalent to being short stock). The trade could be executed in the reverse order, you sell your puts first (i.e. equivalent to buying stock) and push the market up before liquidating your long stock position. But the net overall effect is the same.
If you were long stock and long puts to begin with you would be hedged to a certain extent (you haven’t specified exactly how hedged the position is). By selling stock first, the only thing to consider is that you would be unhedging the position (i.e. taking on more market risk) by being temporarily exposed to the just the long puts (i.e. short deltas). To avoid this this sort of position would normally be unwound in sync (I’m sure you know this though). In this case, and assuming a 100% hedge, the market wouldn’t be affected at all as you unwind your long stock and long puts.
I’m happy to respond to a counter argument if you like. But your logic seems flawed to me. As I said before, it’s equivalent to having 2 trading accounts, one with long stock, and one with a short stock position, and trying to boost returns of the short position by driving down the price with the long position. What you make on one is going to be offset by what you lose on the other.
We’re assuming the # of shares of the stock that your client wants to sell is so large it’s almost 100% certain it’ll push down the price of the stock. And when the price of the stock goes down, the option price goes up (even if none is traded, the bid and ask prices will rise in response to the fall in the stock price. So you know before hand that your client’s trade will cause the underlying price to decline significantly so you sell that first before selling the put (and take advantage of knowing the price decline in advance to sell the puts last.) Even if it’s not market manipulation, maybe material non-public information?
Let’s just pretend that your client has a gazillion shares of XYZ currently trading at $50, and also that he has a gazillion puts on XYZ. For the sake of argument and to simplify the math, lets also assume that these puts are deep in the money puts with a strike of $80 (this position was initially set ages ago when the stock was at $120 and luckily client had these puts in place as insurance). The position is 100% hedged. Now we want to unwind this position by selling the stock and selling these deep in the money puts.
Firstly, let’s address the market impact that unwinding this position would have. You’re selling a gazillion stock and a gazillion puts. You say the market is going to get smashed if we unwind this, but I disagree. The net position your are unwinding is ZERO, and therefore shouldn’t have any market impact. If you unwind it, you’ll be selling stock in the market, but you’ll at the same time be selling puts, which is the equivalent to buying stock. A market maker will likely be buying the puts from you (they are taking a short position on their books) will be hedging by buying the physical stock on the market (which you happen to be selling). The selling of stock and selling of puts have an equal and opposite push on the market which should theoretically result in no net movement of the underlying.
If you sell the stock first, you might drive the price the stock price down to say $40. The average selling price might have been $45, so you’ll lost $5 on the stock. Now you need to sell the puts. As you sell the puts, this is going to drive the underlying market up (the tail wagging the dog) for reasons explained above (arbitrageurs buying puts and hedging by buying stock), and drive the underlying back to $50. You’ll have made the $5 back on the way up selling the put leg as you did losing the $5 on the way down when you were selling the stock leg.
The net effect is the same. The only difference is that unwinding one leg before the other removes the hedge exposing you mometarily to market risk.