I agree with you that not ALL option traders are cash constrained as you correctly pointed out using verticals. But as an energy trader I can tell you that 98% of physical players abhor the cash settled futures. The amount of manipulation in cash settled futures is staggering. You do NOT want cashed settled products. You want options that can be tied to physical so ARBITRAGE can take place and force convergence. Without physical, no true arbitrage can be guaranteed. This also wreaks havoc for option pricing models who all use the no arbitrage pricing mechanism to price options.
The manipulation issue is very real, for sure. I think it's the only valid argument I've seen on this thread against cash settled products, although I'm starting to grasp the difficulties for MM as well. You can certainly arbitrage a cash settled future with the underlying, pretty much by definition at expiration the futures price matches the underlying. At most you'd need to sell that bushel of wheat at spot when your short wheat futures expired instead of offsetting it, but absent some expiration spot volatility risk and small extra transaction costs you're accomplishing the same thing. Energy's definitely a different beast if you're talking electricity which you can't store and arb, but anything else that trade's spot it seems it's a minor inconvenience not a show stopper.
Try this. He was actually one of my professors in Grad School so I might be biased here but his research in this industry is second to none. He has testified in front of congress presenting his research.
"can tell you that 98% of physical players abhor the cash settled futures." I am always bit cautious when anyone quotes a 90%+ with no empirical evidence, but I can tell you that in the portfolio management community almost everyone I've ever met prefers cash settled so their portfolio remains intact. Almost every argument that has made here relates to the bias in the dealer community not the end user community. In the structured upstairs community where more notional trades (In the 40 years I did exchange marketing. to sell side desks)almost no one wanted a physically settled option. Certainly not in indexes or in individual names.
ajackobson++ The option value at expiration is settled against the price of the underlying equity. If manipulation occurs on the equity, so be it. Those who buy or sell it on order to "manipulate" it are still subject to a lot of risk, if the price goes in the other direction. So let them manipulate, they'll suffer consequences.
It's just much easier to manipulate with cash settlement. For example, lets say you have a thinly traded security and you buy $100M in call options that are cash settled. You can then sink $10M into the underlying to drive up the price just before expiration. You could end up with many $100M in profit from the options, and even if you flood the market with your $10M in underlying as you liquidate on the way back down and lose some there, you gained so much on the options it doesn't matter. With physical settlement, you buy $100M in call options and do the same thing with $10M to drive the underlying up, you end up with $110M+ in the underlying at expiration. If you try to sell all that, you drive the price down so much that you probably lose what you gained from trying to manipulate a thinly traded stock in the first place.
What I have to think about is weather you can have $100M of liquidity on options while $10M are enough to seriously affect the price of the underlier. If so, the market makers who place so much liquidity on options actually deserve what will happen to them.
Again don't do it in the thinly traded stuff. Start five names and the new symbology has enough fields. Make them last business, cash settled and do a handful of names - spy, qqqq, rut, aapl, bac,amaz, goog, xom,ibm, cop,t and a handful of others. Just work the most active list. European style cash settlement - they trade upstairs in tonnage. Moving them downstairs aids transparency, liquidity.
That's a straw man. No one believes markets are only for hedgers. My point, which has been amplified by others in the thread, is that without hedgers / real money participants, a market never gets off the ground. An all-speculator market devolves to picking each others' pockets and dies out. There is no fresh energy coming into the biosphere. As to the verticals -- let's agree to disagree on whether 5% on a single position is a large or small risk.