SEC short-sale rule stifling US options trade
Reuters - Monday, October 6 10:18 pm
By Doris Frankel Reuters - Monday, October 6 10:18 pm
CHICAGO (Reuters) - The U.S. clampdown on short selling has made it difficult for option market makers to maintain orderly trading and raised the cost of protecting investments at a time when options are most needed to weather the maelstrom on Wall Street.
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The Securities and Exchange Commission-directed ban on making bets that financial stocks will fall was part of the government's coordinated effort to stabilise the U.S. financial sector. It came after several U.S. bank failures and fears of economic recession.
The ban on the short selling of more than 950 financial stocks, which will be lifted on Wednesday night, has already hindered the growth in the U.S. options market because it raised transaction costs for customers, placed a burden on option market makers and reduced volume.
Investors have found the cost of protection has shot up as bid/ask option spreads become wider in many financial stocks.
"The current restrictions have removed every option strategy in the market that relies on short selling and the options liquidity provided by it," said Joe Corona, director of strategic planning at LiquidPoint, which is part of BNY ConvergEx Group, an options broker-dealer in Chicago.
"This has reduced volume and widened spreads."
Short sellers sell borrowed shares with the aim of buying them back at a lower price and returning it to the lender.
Although option market makers have been granted relief and are able to short stock, the more stringent requirements have made it harder for them to locate a financial stock to borrow. Lenders are now charging them higher fees for the privilege of borrowing the stock.
The result is that put options have become generally more expensive compared to call options.
"The financing costs of stock lending have gone up and market makers are looking to pass that cost through to the investor by widening their markets and increasing the premiums charged for puts," said Peter Bottini, executive vice president at online brokerage optionsXpress Holdings Inc, in Chicago.
"These new rules are just another tax on the back of the retail investor," Bottini added.
It is also more difficult for option market makers to price their options using models dependent on various factors, including interest rates that have become an unknown factor.
"It makes it harder to price an option because you don't know what the interest rates on the stock borrow will be or the availability of the stock loan," said Jeff Melgard, managing member of SMC Option Management, a market maker in Chicago. "It has made my job much harder."
Investors typically use put options, allowing them to sell the company's shares at a specified price within a specified time period, to insure their stock holdings or to place a speculative bet on share weakness. An equity call conveys the right to buy the stock at a given price and time.
VOLUME DROPS
Before the SEC issued a temporary ban on short sales on financial stocks on September 19, two of the top 10 highest volume days were recorded back to back on September 17 and 18 for both total options and equity volume.
More than a record 30 million contracts changed hands on September 18, up 12 percent from the previous day's record-setting overall volume of over 26 million contracts, according to the Options Industry Council.
But during the week of September 22, options trading per day was 12.8 million contracts, 5 million less than September's daily average of 17.8 million contracts, Options Clearing Corp data show.
Option players also note on September 29, when U.S. stocks had their worst day since just after the October 1987 crash and the Chicago Board Options Exchange Volatility Index, known as Wall Street's fear gauge, set an historic closing high, option volume surprisingly did not reach record levels.
In fact, U.S.-listed option turnover on that day only met the average of 17.8 million contracts, OCC data show.
"Given the explosion in the VIX, overall option volume should have been much higher," said Mark Longo, a founder of TheOptionsInsider.com, an options information Web site in Chicago.
"This was the type of day that should have seen close to record-breaking volume -- if not at least be one of the top days."
But on Monday, option volume was about 25 million contracts, significantly higher than last week, as the VIX hit another record closing high with a reading just above 52.
"The end of the SEC ban this Wednesday night has breathed new life into the options market, making investors far more willing to trade options," Longo said. "Today's volume increased nearly 40 percent from September 29, revealing the impact of the impending end of the short-selling ban." |
