Letter from the Chicago Board Options Exchange is a hoot...
Location: Blogs Bob O'Brien's Sanity Check Blog
Posted by: bobo 10/16/2006 10:06 AM
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This really is a must read letter, from the CBOE. It is so filled with dis-ingenuity and falsehood as to rival some of our treaties with the Indians. Read on, and consider the essential predicate its logic relies upon, as well as the legalistic misstatements it's filled with, and then ask yourself....how can the press stand by, silent, while this kind of sham is perpetuated?
First, let's review a couple of essential facts.
Section 36 of the 1934 Securities Exchange Act authorizes the SEC to make exemptions, but only “…to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors…”. Specifically, the protection of equities investors - investors in the stock market. For more on that, read the NCANS letter, where it is exhaustively covered.
The options market maker exemption affords speculators in derivatives, NOT stock investors, reduced costs in the price of their options, due to the lack of any cost to hedge the positions by the options market makers.
That exemption allows options market makers to sell naked, legally, affording them the ability to hedge their put options at virtually no cost to them.
But that isn't a no cost transaction. The cost is borne, not by the derivatives speculator, nor the options market maker, but rather, by the equities security investor - who receives no benefit from that subsidy. So this derivatives market liquidity is at the DIRECT EXPENSE of stock investors, who shoulder the burden in the form of increased dilution of their holdings in the stock market, by the options market makers - with a resultant depressive impact on the value of the stock the investors own.
That's a long way of saying that derivatives liquidity provided by naked short selling HURTS stock investors - so derivatives market makers and speculators can have cheaper trading.
Now, here's the problem I have with this letter, and I want you to keep it in mind as you read it:
1) The SEC doesn't have the authority to grant exemptions for derivatives markets, that are destructive to the public interest (including stock investors) and are at odds with investor (stock investor) protection. In fact, the SEC doesn't have the right to choose one business segment's interests over those of investors - which is what this exemption does - thus, it conflicts with the 1934 Act.
2) In the introductory statements, the letter says that SHO (Rule 203) appears to be operating as intended. That is only true if the intention was to create more FTDs over time than before the rule - we know from the available FOIA data that is EXACTLY what the operation of the rule has achieved. More delivery failures now than before the rule was implemented. No arguing that. Note that the letter cleverly uses the SEC's materially false and misleading statement that Reg SHO is "working" as the basis for its conclusion that things are great.
And we know that is a lie.
Thus, the entire logic of the document is predicated on a lie, and on encouraging the SEC to continue to grant options market makers an exemption that the SEC ISN'T EMPOWERED TO GRANT - per Section 36.
The arguments it presents are straightforward: If you don't continue the free lunch for options MMs, then there will be an actual cost to that business, which will be more expensive than free, which is what we currently enjoy - due to the equity investors paying the freight.
No kidding. You mean costs increase when privileges that cost someone else a bunch (but you get for free), are now paid for by the person enjoying the benefit - you? Wow. Who knew? Sounds like that is good for stock investors, who enjoy no benefit but currently pay for the liquidity, and bad for options speculators, who do enjoy the benefits from options speculation, but receive those benefits for free, carried by stock investors.
The other argument is just a variation of this first one - if options MMs had to borrow stock to hedge, it would make options more expensive...because stock investors are no longer paying the freight for the options MM hedging. OK. We get it. Too bad. That the CBOE pretends that options should be priced without any regard to scarcity of the stock sounds rather like communism - the ruling party should get potatoes for free, regardless of how expensive they are in the real world. It is a divine right of sorts.
Unfortunately, nobody authorizes the SEC to hand out those sorts of windfalls, at stock investor expense.
Sounds like the idea that options speculators should pay more to speculate in highly shorted stocks is an appalling idea to the CBOE - but they can't actually explain how it is unfair. Just that they don't like it. I'll be they don't.
Then, there's a specious argument that guns don't kill people, bullets do. Wrong. Killers do.
They argue that options MMs have no reason to want stocks to go down due to their massive naked short selling. Which ignores that their derivatives speculator customers often do, and use the options MM exception in order to create unlimited supply of bogus shares, specifically to depress the prices of stocks they are short. These aren't stupid people - and it really reminds me of the book where the gun manufacturer is marketing to gang members, but claiming that it's innocent of the consequences arising from the butchery committed by their customer base. Didn't work too well in the book. Doesn't really fly with me, either.
Read the letter. And keep in mind that options MMs do not have a God-given right to make free money at the expense of stock investors. That right has been given to them, as a gift, by the SEC, who isn't actually empowered to do so.
Particularly consider how they are very concerned about how the price could run up from the options MMs actually having to cover the stock they created from thin air, but have no concern over the depression caused by the creation of that stock and the dumping of it into the market.
What the hell is going on in these people's heads?
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This just in - apparently UBS was letting their big traders know a day before an upgrade or downgrade was coming. Read all about it here.
Who knew that was wrong? You mean, trading on non-public information ahead of anyone else knowing it is a no-no?
Huh.
And I'll just bet that no hedge funds were leaked that info so they could increase their trading profits, or that UBS' own trading desks didn't take positions and frontrun that, at direct investor expense.
Every day a new example of Wall Street's boundless crookery is exposed, even as the hypocrites that run the business act as though they are as honest and pure as the driven snow. And the notion of an honor system being workable is still the prevailing wisdom.
WTF? WTFF?
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