An academic study argues there is evidence that stock prices are being manipulated by proprietary traders, according to DW sister publication Compliance Reporter. Allen Poteshman, assistant professor of finance at the University of Illinois at Urbana-Champaign and co-author of the paper, said in the week leading up to expiration option sellers buy or sell shares in the underlying stock in order to prevent the options from expiring in-the-money. Poteshman said the Securities and Exchange Commission took an interest in the issue after he presented it to former SEC chief economist Lawrence Harris. An SEC spokesman declined to comment.
Harris, now at the Marshall School of Business in Los Angeles, said the paper's authors have assembled evidence that is consistent with manipulation but does not prove it. "Compliance officers need to closely monitor trades near the close of the expiration date in securities where traders hold large expiring short positions in the associated options," he added.
"There are some valid points, but I didn't see a cast iron case," said Paul Crouch, ceo of Direct-Issue.com. "It is generally accepted that the markets are not perfectly liquid and they affect each other." He added the effect in itself shouldn't be seen as market manipulation. For example, it would be perfectly legitimate for an option trader who thinks volatility will be low to sell options even though it could have a self-fulfilling effect because the selling may dampen volatility.
Crouch, who was previously head of equity derivatives trading at Lehman Brothers in London, said he has seen what looks suspiciously like market manipulation during his trading career, but says it is always hard to prove and is a high-risk strategy. "You need to be the largest player and even then something bigger could come around the corner," he explained Nick Leeson at Barings Bank was the largest futures trader in Singapore and succeed in temporary pushing down vol in the Nikkei before the Kobe earthquake forced vol sky-high, pushing his positions out of the money and bring Barings to its knees.
The paper will be published in the Journal of Financial Economics.
