August 21, 2007
Why is the SEC the last entity to know what is going on?
From page C1 of The Wall Street Journal, August 17, 2007 by Scott Patterson:
As investors aggressively snap up puts, the market makers that sell these options also sell the underlying stocks or indexes to reduce their risk profile. Their selling can create a self-reinforcing downward spiral as investors gobble up puts and market makers sell more stocks behind them.
The option market maker exemption must be removed entirely if any investor is to have any hope of any market integrity. No one should be allowed to sell shares that do not exist.
Traditionally, it was claimed that short selling stabilized markets, as stocks were shorted when prices got too high, and shorts were covered when the price dropped. In fact, rampant shorting destabilizes the market place. As one example, when the price of NFI was relatively high, it had a relatively low short interest. For the past several years, that short interest has steadily climbed as the price dropped, to the point that there are now 8,104,561 shares reported short for a company that only has 9.5 million shares issued. In addition, open put interest has risen to an all-time high with contracts representing 11.2 million additional shares that may have been sold but not delivered using the option market maker exemption to Reg.SHO.
Trading in NFI often involves large numbers of put contracts trading simultaneously with the dumping of shares exactly corresponding in number to the put trades. Very strange option trades occur. Today for example, 820 October 15 put contracts were sold, at a price that would yield no profit to the put buyer unless NFIs price were to drop by over 20%. Even then the profitability of the trade would be quite minor relative to the cost of purchasing the puts.
Apparently everyone but the SEC can see that the option market maker exemption was nothing more than an invitation to manipulate stock prices. The SEC, on the other hand, issued special exemptions to reporting requirements so that specific hedge funds no longer report their put holdings. It is a very biased system that requires reporting by any person who is long 5% of a companys stock, but intentionally conceals any person who might be short 200% or more of a companies legally issued shares.
Not only must the option market maker exemption be removed from Reg.SHO, but Reg.SHO must be further tightened to require prompt delivery of every single share sold, and sellers who repeatedly fail to deliver what they have sold should face significant economic penalties, such as refunding to the buyer three times the value of the transaction on all fails that persist for more than 20 trading days.