Short Restrictions and Market Makers

Discussion in 'Options' started by rew, Apr 27, 2012.

  1. rew

    rew

    Do short sale restrictions on stocks apply to option market makers? If so, how do they stay delta neutral on, say, short puts on that stock as the price goes down?
     
  2. rmorse

    rmorse ET Sponsor

    I believe that option market makers are except from getting a locate on hard to borrow securities but are not except from the short sale rules in case a plus tic is required.

    Bob
     
  3. FSU

    FSU

    I think you are wrong here Bob. If MM's were exempt from this requirement, they could make a fortune shorting hard to borrows vs options.
     
  4. rmorse

    rmorse ET Sponsor

    I know MM that won't give up their BD and membership because they only make money on the hard to borrow securities. I left the floor in Feb 2010, and the rules have not changed. It is meant to allow depth and liquidity in the options and the SEC expects that when you sell these stocks without a locate that you're hedging an option trade or have that intent. You can still be bought in like everyone else, but you can sell short when others can't. This was the only doc I could find.

    http://www.amex.com/amextrader/tdrInfo/data/axNotices/2007/reg07035.html
     
  5. zdreg

    zdreg

    Question 4.7: Market makers, as defined in Section 3(a)(38) of the Exchange Act, include block positioners. Regulation SHO provides an exception to the locate requirement for market makers. Are all block positioners excepted from the locate requirement?

    Answer: Rule 203(b)(2)(iii) provides an exception from the locate requirement for short sales effected by market makers, but only in connection with bona-fide market making activities. Rule 203(c)(1) provides that the term “market maker” has the same meaning as in Section 3(a)(38) of the Exchange Act, which defines “market maker” as “any specialist permitted to act as a dealer, any dealer acting in the capacity of a block positioner, and any dealer that, with respect to a security, holds itself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for its own account on a regular or continuous basis.”

    The term “block positioner” is not defined in Regulation SHO or the Exchange Act. However, for purposes of Regulation SHO, the Staff interprets this term to have the same meaning as in Rule 3b-8(c) of the Exchange Act (17 CFR 240.3b-8(c)), which defines a “qualified block positioner” as a dealer that: (1) is a broker or dealer registered pursuant to Section 15 of the Exchange Act; (2) is subject to and in compliance with Rule 15c3-1 of the Exchange Act (17 CFR 240.15c3-1); (3) has and maintains minimum net capital, as defined in Rule 15c3-1, of $1,000,000; and (4) except when such activity is unlawful, meets all of the following conditions: (i) engages in the activity of purchasing long or selling short, from time to time, from or to a customer (other than a partner or a joint venture or other entity in which a partner, the dealer, or a person associated with such dealer, as defined in Section 3(a)(18) of the Exchange Act, participates) a block of stock with a current market value of $200,000 or more in a single transaction, or in several transactions at approximately the same time, from a single source to facilitate a sale or purchase by such customer, (ii) has determined in the exercise of reasonable diligence that the block could not be sold to or purchased from others on equivalent or better terms, and (iii) sells the shares comprising the block as rapidly as possible commensurate with the circumstances.

    Therefore, block positioners may rely on the exception to the locate requirement in connection with bona-fide block positioning activities.

    Question 4.8: What constitutes “bona-fide market making activities?”

    Answer: The term “bona-fide market making” refers to bona-fide activities described in Section 3(a)(38) of the Exchange Act. Whether activity is “bona-fide” will depend on the facts and circumstances of the particular activity. However, the Adopting Release sets forth examples of activities that would not be considered to be “bona-fide market making activities.” (69 FR at 48015).
     
  6. If the hedge is hard to do, the option price & liquidity reflects it.
     
  7. rmorse

    rmorse ET Sponsor

    That's true for Reg Sho stocks where the market maker is confident they will get bought in as time passes, the price of the call bid is reduced and the put offer is increased to be paid for their risk.

    The reality is that many of us want to short hard to borrow stock for a trade. That trade might be 10 seconds, 10 minutes or 10 days. If your Prime Broker has no stock in inventory and can't receive a locate, they won't give you one. So you can't do anything from the short side of the security. Options market makers don't have to ask.

    There have to be some advantages to remaining a MM or who would bother the the regulations and expenses.

    bob
     
  8. rew

    rew

    What about stocks with a short restriction due to simply falling too far too fast? Can option MM short those? For example, today PBH has a short sale restriction in effect because a bid to buy the company has been withdrawn so the stock tanked by 15%.
     
  9. rmorse

    rmorse ET Sponsor

    Yes they can short them without a locate. The question I'm not sure about is the the plus tick rule when it applies. It's my expectation they are not except from requiring a plus tick when required by the exchange.
     
  10. Options12

    Options12 Guest

    The complaint below includes some useful info regarding the market-maker exception.

    In this case the SEC contends that the respondents collected $17 million by improperly utilizing the market-maker exception:

    7. The Respondents in this matter, who were not conducting bona-fide market making activities but were instead engaged in “naked” short sale transactions for their personal investment purposes, improperly utilized the Market Maker Exception from Rule 203(b)(1) in order to avoid locating shares before effecting short sales as part of “reverse conversion” and “assist” transactions, as further described below. Because the Respondents failed to borrow or arrange to borrow securities to make delivery when delivery was due, the short sales as part of the reverse conversions and assists were “naked” short sales. These same Respondents also violated Rule 203(b)(3) by repeatedly engaging in a series of sham transactions to ostensibly “reset” the thirteen-day clock for complying with the close-out requirement, but without actually purchasing shares in a bona fide transaction. These sham transactions enabled the Respondents to circumvent Reg. SHO, allowed them to generate millions of dollars in profits because they did not actually borrow or arrange to borrow the securities they were selling short, and caused their clearing broker to have large persistent fail to deliver positions in these threshold securities, thus undermining one important purpose of Reg. SHO.

    http://www.sec.gov/litigation/admin/2012/34-66283.pdf

    http://www.sec.gov/news/press/2012/2012-22.htm
     
    #10     May 3, 2012