Beating the Market Makers

Discussion in 'Options' started by CaptainObvious, Jan 30, 2007.

  1. I found this on a blog and was wondering what some of you pros think of this method. Any risk here I'm not seeing?

    Option Trading Blog
    Avoid The Option Expiration Rip-Off!
    Posted by Pete Stolcers on June 9
    In today’s option trading blog I want to try and save you some money. Have you ever been long an in-the-money (ITM) option and cursed at the Market Makers because the options were bid under parity? I have and there is a way to by-pass them altogether. This article could save you hundreds, maybe thousands of dollars.

    Let’s look at an example. You are long 10 of the $50 calls and the stock is $58 x $58.10. The options are $8 in the money but the market on them is $7.80 x $8.20. You want to get out at a decent price so you try to sell them at $8. The order sits and it never gets filled. Now you get angry because you know that you are being taken advantage of. The Market Makers are in the business to make money. They figure you don’t know any better and eventually you’ll hit their bid. Here’s how to get out and keep your money.

    The first thing you need to do is to find out how your brokerage firm handles this transaction. You are long calls and you can exercise your right to buy the stock at $50 – theoretically you’re long stock. If you sell the stock and exercise your calls you will be “flat”. The transaction is short exempt by rule and reg. and you have what’s called – same day substitution. This means you don’t have to put up the stock margin if it is done the same day. The brokerage firm will require advance notice of your intent to exercise. Once they have it they will create an offset that makes your account long 1000 shares.

    Here’s how you handle the trade. Lets say that the stock is offered at $58.10. You place an order to sell the stock at $58.05 and you get filled. Now you exercise the call. The net affect is you bought shares at $50 and sold them at $58.05. Your net price is $8.05 which is $.25 better than the $7.80 the Market Makers were willing to give you. That’s $250 in your pocket. The Market Maker was hoping to do the reverse. First he would buy the calls for $7.80 and then he would hit the $58 bid on the stock. The end result is a quick $200 risk free profit.

    If you have the margin available in your account and you are selling the stock on an uptick, you can just do the transaction without notifying the brokerage firm in advance. You do need to put in an exercise notice either verbally or through the trading application so that both sides of the trade clear and the margin is released.
  2. No risk--I've done this with IB frequently.

    I've not looked deeply into the accounting details. If you're short stock and exercise calls, IB immediately makes the position go away--no waiting for midnight. Whether I'm being "charged" margin or not isn't clear.
  3. virgin


    Interesting !
  4. I've done it as well with thinkorswim, in a similar circumstance.. I lost track of time on exp. Friday..

    I was long a handful of BBY calls from a leftover vertical that were in the money by over $1.50 or so, and when the closing bell on expiration rang I was sitting there astonished, wondering what to do, as I did not have 25k to be long the stock on Monday AM, and didn't want to bother with the margin call, ect ect. I called up, they shorted the stock after hours for me and exercised the call.

    By the way, do you mind posting or PMing me the blog you are referring to.
  5. I have done this with futures and options on futures on expiration day where the b/a is much wider. If you have a diagonal for example and the short leg is ITM and you want to close it out to roll next month or make some other adjustment, the ask to buy back is gonna cost you.

    One thing you can do is simply go long the futures right before the close on the ITM short calls and when they are assigned your long futures goes away.

    For example, you are short ES 1430 Calls on the short leg of a diagonal and the ES is at 1436 just before market close on expiration. I would bet that ask to close the short calls is probably 6.50 as I have seen in the past or more with no luck in getting a splt of the b/a. If the ask cannot be shaved and the ask is well above the current value of the ES, simply go long the ES here at 1436 and when the short calls are exercised it is like covering the short at 6.00.

    THis works the deeper ITM the short call is so you do not get whipsawed into something worse and wait until near the close unless you are really ITM and feel lucky. Basically you could save $0.50 to $0.75 if you are having trouble splitting the bid/ask to cover a short leg of a call spread which is ITM.

    Just make sure you have margin available to go long the futures since the futures will not get assigned away until over the weekend.

    Anyway it is not a major trick but as pointed out above, if the b/a is wide and you are having trouble splitting it and wish to cover the option, convert it to a covered call or put so that you get assigned at intrinsic value.

    Hope this makes sense...
  6. The blog link for everyone. This guy does run an advisory service which I have no experience or affiliation with. Thanks to everyone for sharing their experience. Still trying to get a handle on options trading, other than buying calls/puts.
  7. ellevers


    parity plays are a great way to take advantage of inefficiencies in the market place. They usually set up when there is news in a stock and it is up or down big and has pretty good open interest in the strike. When the stock is up big, the people that owned the otm calls that were cheap are now worth something and are willing to sell it on the bid because if you just made a dollar or more on the option. The person is not going to worry about just hitting the bid to get out of that great trade they had. That is why they set on the reversal side. Then the conversions set up on the put side when the stock is down. The other thing to take in a count is how much your broker charges to exercise the options.
  8. ChrisM


    I think that many traders use this technique and not making a big story about it.

    We had that discussion some time ago while talking about locking in profits from VIX options.

    Another version of this is not waiting till expiration, but with a little addition such technique can give you the chance to lock in profit once your option is deep ITM.