Market Manipulation: A Recipe in Three Parts
Price Manipulation and its cousin “mismarked books” are as much a product of systemic
dysfunction as they are of unethical individual behavior. The 3 part series we have planned is educational in nature and aims to outline those system-wide imperfections at the highest level.
For today we must focus on what is shaping up to be a rare opportunity to watch a pitched battle between major players in Gold. In short, we are interrupting your regularly scheduled program.
Current Events: The Potential Pin in Gold Options Tomorrow
Right now there is a war in Gold options. It is between the May 1520 longs, who mostlikely are unhedged, and their short option counterparts, who most likely are hedged.One would think the longs intend to sell futures at some point, perhaps 1520, perhaps1540 we do not know. It is also possible that they intend to take delivery, but that isunknowable for the moment. The shorts are probably delta hedgers and have no desireto see this market go above 1520, much less move at all.
The Players
The Longs- have accumulated over 5,000 lots in a two week period and wewould assume they are bullish. They are patient dip buyers and seem to havelittle fear of the Bullion Banks that are often accused of manipulating PM priceslower or keeping prices range bound at expiration.The Shorts- are Bullion Banks, market-making firms, locals and possibly somehedge funds. There is no collusion implied here. In fact, these firms are usually atodds with each other in terms of option open interest. The majority of the shortstrade options from a non-directional point of view. That is, they are professionalswho, when short an option do not want the market to move either way.Conversely, when they are long an option, they want the market to move quicklythrough or away from the strike they own.
The Play
We feel the Longs were betting that once the gravitational pull of the $1500 strike wasbroken, that the market would move quite easily to the strike with the next largest openinterest, the $1520 strike. They may be privy to large order flow in futures, they mayhave large futures order flow, or they may simply be speculating with nothing other thantheir wallets and the ability to read market behavior through price action. They can spota market that is lopsided in one direction when they see it.
Snapshot: May Gold Open Interestproduct contract type strike volumeopeninterest
OG May-11 C 1480 598 2303OG May-11 P 1480 368 675OG May-11 P 1485 271 341OG May-11 C 1485 11 666OG May-11 C 1490 5 970OG May-11 P 1490 379 416OG May-11 P 1495 86 280OG May-11 C 1495 35 361OG May-11 C 1500 211 6762OG May-11 P 1500 445 522OG May-11 P 1505 17 333OG May-11 C 1505 76 306OG May-11 C 1510 507 1731OG May-11 P 1510 344 116OG May-11 C 1515 116 1374OG May-11 C 1520 580 5823OG May-11 C 1525 143 747OG May-11 C 1530 128 578OG May-11 C 1535 95 289OG May-11 C 1540 9 730OG May-11 C 1550 40 1570OG May-11 C 1600 26 1515
The Next 48 Hours
We have alerted the reader to this possibility for the past week. All that remains is this:
Today the LME is closedThis deprives the market of a deep source of liquidity. While the LME Players are surely
watching and trading today, we suspect the “A’ teams may not be
, however, as holidaycontinues for many and trading at 9PM London time is not very fun if you are an MD ata large Bank. Also remember there was no LME fix today, which has an effect onbalance sheets for London firms. No London Fix, no Balance Sheet Axe, so to speak.
Tomorrow Comex Options ExpireIf the Option Longs are right, then the market will be propelled through the 1520 strike.Futures should receive additional support at some point from the negative gammahedging of those non-directional players who MUST adjust their delta hedges. The
longs are playing for a longer time line than the shorts in this instance.
If the Option Shorts win this battle then we will pin the strike. Remember, a violent sell-off is not good for the shorts either. A pin means the options go out worthlesstheoretically, and the future hedges that longs carried against those shorts can beliquidated for a profit.
Let’s assume next that the Options Shorts “win” this battle and through hope, prayer, or
their own attempts to keep the market in a range, the $1520 strike is Pinned or near-Pinned on the closing bell at 1:30 PM ET tomorrow.
The Pin
If a Pin occurs, the longs have another two and a half hours to decide if they wish toabandon or exercise their calls. They own the optionality at the strike. The option shortscan still lose a lot of money, even if the option longs make none. A sell-off is verypossible, wherein the option longs abandon their calls, but the option shorts still havehedges to unwind. The Shorts would be forced to use statistical methods to determine ifthey will get exercised or not. More than likely this is a digital event, and statistics do notmatter when most of the contracts are in the hands of a single player or a group of likeminded players, as may be the case here. We are likely looking at an all-or-noneexercise if we pin the strike. The shorts would be in the dark.
Manipulation in the Metals Market
A multitude of individuals and firms have been accused of market manipulation, over theyears. Many individual traders have been brought to task for their actions. The HuntBrothers attempt to corner Silver, Yasuo Hamanaka of Sumitomo for his coppermanipulation in 1995, by
, various “rogue’ traders
and brokers and most recently, theCFTCs successfully prosecuted of a case involving Brian Hunter of Amaranth for hisactions in the natural gas market. Nonetheless, very few firms have sufferedcommensurately.
Business as Usual
Firms that have been successfully prosecuted continue to operate in the markets theyhave manipulated, usually with monetary wrist slaps. To be fair, major firms settledisputes all the time, but the fines are not proportional to their balance sheets when
compared to the individual fines; nor are the firms’ abilities to go back to business
-as-usual in the market place affected.
It’s Baked in the System
We believe manipulation is a product of many things, and attempt here to boil themdown to three
broad categories. First, the U.S. Government’s accounting and regulatory
policies unintentionally enable these events to occur. Second, the rights accorded
|