A ban on naked short sales...

...will increase the liquidity of the derivatives market... options on both equities and futures... this will lower the ROI of option writers by tightening the spreads...

...will increase the liquidity of the derivatives market... options on both equities and futures...

this will lower the ROI of option writers by tightening the spreads...

I dont know too much about options but I am really curious about one thing.

If short selling is banned, how option writes can hedge puts?

Edited by A-ha, 18 September 2008 - 09:37 PM.

...will increase the liquidity of the derivatives market... options on both equities and futures...

this will lower the ROI of option writers by tightening the spreads...

I dont know too much about options but I am really curious about one thing.

If short selling is banned, how option writes can hedge puts?

You asked: "If short selling is banned, how option writes can hedge puts?"

i don't understand the question... option writes don't hedge puts (options)... they hedge physical positions... or a deposit towards physical positions... so if short selling is banned... the only way to lean towards the downside would be through puts... which would increase the liquidity in the options markets... which would tighten the spread between strikes... hence reducing ROI for writing options.

Option market makers (the largest volume players in the option universe) do hedge put sales with selling of Delta equivalent stock short and in addition buy and sell stock short to adjust to swings of the inventory. For example if after they sold 1 mil worth of stock the particular stock tanked they would have to sell short more so that their hedge would be current. If they were not permitted to lay off by selling stock they would widen their spread drastically thus making it more expensive for the public.Option market making is risky as it is and not being able to hedge most firms would just abandon their market making commitments. I wonder if the short sale rule applies to them. Best, F&D

Option market makers (the largest volume players in the option universe) do hedge put sales with selling of Delta equivalent stock short and in addition buy and sell stock short to adjust to swings of the inventory.

That is exactly why I asked because those are the big whales that move the market... if S&P broke below 1110 today, I bet my doggy's nuts that there would have been a delta hedge meltdown.

Option market makers (the largest volume players in the option universe) do hedge put sales with selling of Delta equivalent stock short and in addition buy and sell stock short to adjust to swings of the inventory.

That is exactly why I asked because those are the big whales that move the market... if S&P broke below 1110 today, I bet my doggy's nuts that there would have been a delta hedge meltdown.

SPX can break 1000 without damaging put writers... and w/ options on futures (say ES dec contracts) the draw down on a wide spread (say down to 900) is nothing... thats what options are for.

Edited by TheArchitect, 18 September 2008 - 10:21 PM.

Actually the most volatile component is the people doing credit spreads. They are a lot of professional traders end hedge funds who play this with huge numbers. If one expects the market to stay afloat or pop up or even decline slightly they would sell a put slightly under the market and buy one less expensive several strikes lower - receiving a credit- hoping that the higher price put(the short leg) will erode faster then the lower priced long put and they can keep the difference. If there is a sudden move the short leg will be in the money and there will be a desperate rush to cover or roll lower. Of course if a market maker is on the other side facilitating them then the market maker would hedge shorting physicals thereby pressuring the market. Because the volatility is so high, premiums, specially on puts are high and it is very tempting. They are other twists to it, of course. Needless to say the opposite of this is credit spreads with calls where a sudden up move would rip them. This used to be an esoteric insiders game but in the last five years a lot of futures programs and funds have been doing it, selling it to the public as a low risk game. F&D

Actually the most volatile component is the people doing credit spreads. They are a lot of professional traders end hedge funds who play this with huge numbers.

If one expects the market to stay afloat or pop up or even decline slightly they would sell a put slightly under the market and buy one less expensive several strikes lower - receiving a credit- hoping that the higher price put(the short leg) will erode faster then the lower priced long put and they can keep the difference.

If there is a sudden move the short leg will be in the money and there will be a desperate rush to cover or roll lower.
Of course if a market maker is on the other side facilitating them then the market maker would hedge shorting physicals thereby pressuring the market. Because the volatility is so high, premiums, specially on puts are high and it is very tempting.
They are other twists to it, of course.

Needless to say the opposite of this is credit spreads with calls where a sudden up move would rip them.
This used to be an esoteric insiders game but in the last five years a lot of futures programs and funds have been doing it, selling it to the public as a low risk game.

F&D

all i'm saying is that you can sell far enough away from current settlement to make it a low risk game... however the lack of involvement on the sell side will increase the open interest in the put options... therefore decreasing the spread... and increasing the risk by lowering the ROI for writers.