August 14, 2007
As a private investor, I have witnessed and reported numerous abuses of the options market maker exemption. Specifically, the options trading on NFI (Novastar Financial) has been blatantly manipulative for many months, with millions of shares worth of put options often trading every day, paired with equivalent blocks of shares being simultaneously generated by the options mm and dumped on the market. This has had the effect of creating an enormous artificial float that has helped to severely depress NFI's share price. The quantity of options trading on NFI (particularly put options) has steadily increased over the past year or so, to the point where it is now way out of proportion to such a small company with a tiny market cap, and seems clear evidence of manipulative intent.
The SEC acknowledges the options mm exemption is being used by some market makers in ways that violate the original intent of the exemption, and potentially harming holders of the stock who have nothing to gain from these derivatives trades. It is simply not fair to force shareholders to bear the burden of hedging the options mm risk. Let the derivatives players bear the burden by paying higher prices where appropriate for illiquid options, or simply discontinue options trading in those stocks where the market can't price them rationally.
Since only a small number of options market makers are probably involved in this manipulative activity, the vast majority of honest market makers would not be harmed. Why protect the corrupt ones? Please eliminate this exemption as soon as possible, so that these abuses will stop. Thank you.