http://www.theoptionsinsider.com/comment/?id=127 Despite Soaring VIX, Short Selling Ban Sends A Chill Through The Options Market Posted on www.theoptionsinsider.com In Comment Letter by Mark S. Longo One For The Record Books There has been a lot of talk about the explosion of options volume that took place in September. There certainly is a great deal to celebrate. Overall options volume amounted to 374,531,673 contracts last month. That is an incredible 84% jump from September 2007. The options market also set a new record for monthly volume, surpassing the old record from July by 2.3%. Equity options volume also set a new record in September. 341,301,652 equity option contracts changed hands last month. That is a nearly 87% increase from September 2007. If that wasn't impressive enough, two new daily volume records were also set last month. More than 26 million contracts changed hands on September 17. That stunning total was immediately surpassed on September 18 when options volume exceeded 30 million contracts. With so many new records on the books in September, the term "banner month" is an understatement of epic proportions. Unfortunately, the SEC had a surprise up its sleeve that would quickly send a chill throughout the world of options. Short Selling Ban Breaks the Options Market Despite a flurry of new volume records, all was not rosy in the options market last month. When you dig beneath the surface of the volume numbers, the impact of the SEC's recent short selling ban comes into stark relief. In virtually every sense of the word, the SEC broke the options market in September (read "Black Monday Redux" Sparks Historic VIX Rally, But Short Selling Ban Stifles Options Market for more information). There's no better way to illuminate this than by looking at the daily volume numbers from September: Click here for the complete article including September options volume data
There could be another reason for falling volume. The IV of all the options has exploded thru the roof. Options are so expensive to buy until volatility comes down I think options volume will fall
Two reasons for falling volume: 1.Inability to hedge deltas ( MM) 2.Huge bid/ask spread (Vix/fear) combined with lower stock nominal ( Retail)
I think it's a combination of several things: - exploding premiums making options too expensive - market makers and customers having no clue what was allowed under the ban - market makers being unable to hedge, so they widened out their spreads
I think the latter is the key part of that equation. If the market makers can't hedge, then everything else is pretty much moot. Liquidity will drop and spreads will widen out to reflect the increased risk in the marketplace.