Go MARKET!

We interrupt this euphoria already in progress for some feedback.

Got forwarded this email via Minyanville.

Here’s a question– will the ban on short selling alter the put/call skew for individual names as well as indexes? Are there opportunities there?

The answer is very much yes.

Options on a given strike are priced to put/call parity. The call price plus the strike price of the option minus the put price is equal to the forward price of the stock. The forward price of the stock is essentially the price of the stock on the board minus dividends between now and the options expiration, plus the cost of carry. Not allowing shorting of stock (or charging money to short the stock) effectively reverses the cost of carry from a positive to a negative.

So let’s say we have a $130 stock (guess what name I might have in mind). And let’s say that stock pays no dividend. And let’s say the cost of carry (interest) between now and expiration is $1. The calls will trade for $1 more than the puts.

Now let’s say overnight, the stock becomes unshortable. Cost have carry has now gone to …….really a guess until this sorts out. But the market makers can’t short stock so they can’t easily and effectively hedge any bullish orders they get. So they must raise their puts and lower their calls. And ergo if the stock is unch., the put/call combo may move $1 or $2, or whatever really.

This has all sorts of implications. For the MM, he almost certainly has the wrong position on for an instant repricing. I traded on the AMEX for 13 years, the most common order you see is a call seller, next is a put buyer. You take the other side, so you virtually always have a position on where you’re long calls, short puts, and you short stock to hedge. So it’s an instant P&L hit. Which I’m sure will not elicit much sympathy.

But going forward, he now has a better trading environment. He can plausibly raise his put offers, and decrease his sizing. And trust me, smaller size at better prices works way better for an MM.

And worse for everyone else. Unless you would prefer less liquidity and wider quotes.

Is there opportunity? I suppose. If you can figure out a way to synthetically manufacture short stock at a price effectively parity to the actual stock, you can sell those fat puts and buy those cheap calls, and lock in an arb. But don’t try it at home, as like I said, liquidity is now wildly limited, bordering on frozen.