Tuesday, July 12, 2011

Who "Knifed" Apple? - Market Manipulation

I recently read an Article on CNN entitled "Who Knifed AAPL?" AAPL is currently trading at $353.
Below is the summary, with some more explanation behind it:

Sell some out of the money calls - say the July $360 calls for $2 each. This Friday is expiration Friday, meaning the option expires in 3 days.
Now, if AAPL goes up to $365, the calls are in the money, and the seller of the $360 will lose $3 ($5 in the money, $2 profit from sale).

To avoid this loss, the seller of the calls will try to lower the price of the stock to his own gain. He will sell stock to increase the supply of shares (simple supply and demand economics). This increase in supply will lower the price of the stock.
Here is the graph from last expiration Friday (which the article is based on).
screen-shot-2011-06-16-at-3-08-24-pm.png (207×388)
Notice that volume increases very close to close. The article alleges this increase in volume is not legitimate trading, but traders looking to lower the price of the stock for their gain.
Then, on Monday, the traders would buy stock (if they sold short, or to re-establish a position).

Here is my parting shot: Apple's average volume is 14,828,000 shares. To increase the supply of shares drastically, you have to move a lot of shares -, at $330.
If someone really wanted to employ this strategy - they'd be doing it with a $5 stock with few shares. Exchanges have surveillance's in place, if traders were to attempt this strategy, a red flag would come up.

A Protective Collar

In my last post, I discussed a collar strategy. However, this strategy had the underlying assumption that the portfolio has no stock to begin with. The collar strategy was employed to limit risk and reward, given a certain set of speculations. Now, assume that an investor owns 100 shares of LVS (ended the day at $43.35). This investor wishes to keep holding onto LVS until September, but has a worry the company's stock may drop. The stock can not be below $39, when the investor plans to sell the shares (say, to pay for Fall Semester). A rise in the stock price will be welcomed, but not required.

The first option of the investor is to simply put a limit order, where the stock will automatically sell once LVS hits $39. However, if LVS hits $39 in July then rallies, the investor will have sold at the lowest point.

The second option is to buy a simple $39 put. This leaves all the upside, but this put costs $1.35. So, if the stock remains unmoved, the investor only nets $41.65 per share.

To off-set the cost of this 39put, sell an option for $1.35. This turns out to be the 48 call. This is a free collar, as the profit of selling the call pays for the cost of buying the put. If the stock goes up, then money will be made until the stock rises above the price of the sold call.

In summary:
1) Own 100 shares of stock.
2) Buy $39 put, for $1.35
3) Sell $48 call, for $1.35

Maximum risk: $43-$39 = $4 per share
Maximum reward: $48-$43 =$5 per share
Here is the P/L chart comparing the previous collar strategy (no stock) to one with stock. 
Remember an option only collar here involves
1) Sell the 39 put and
2) Buy the 48 put
 OR
1) Buy the 39 call
2) sell the 48 put

 Where the protective collar 
1) Own 100 shares
2) Buy the $39 put
3) Sell the 48call

Notice how the option only collar utilizes only puts or only calls where the protective uses both a put and a call.