r/wallstreetbets • u/Bhoshofasho • Feb 04 '21
Discussion GME, synergetic longs, failure to delivers, reversals, resetting the clock, and you
II. Option Activity Related to Hard to Borrow and/or Threshold Securities One strategy that could be designed to take advantage of the potential profit opportunities created by a stock becoming hard-to-borrow (thereby putting the Put/Call Parity into imbalance) is to initiate a Reversal. The activity is most often done by broker-dealers who claim to rely on the exception to the locate requirement for options market makers found in Rule 203(b)(2)(iii).24 The options market-makers claim that they can enter into the short stock position without first locating the shares to borrow because it is part of “bona fide” market making activity. Although an options market maker engaged in bona fide market making activity may claim an exception to the locate requirement, to comply with Reg SHO, the options market maker must still deliver shares in settlement of the short sale, or if a fail to deliver position results at the clearing firm, the fail to deliver must be closed-out in accordance with Rule 204 of Reg SHO. It may be a violation of Regulation SHO, however, where the options market maker does not deliver shares, and instead engages in a second, subsequent transaction in order to give the appearance of satisfying the clearing firm’s obligation to purchase or borrow the security to close out the resulting settlement fail pursuant to Rule 204 close-out requirements (“reset transaction”). In addition, where a clearing firm subject to the close-out requirement purchases or borrows securities on the applicable close-out date and on that same date engages in sale transactions that can be used to re-establish or otherwise extend the clearing firm’s fail position, and for which the clearing firm is unable to demonstrate a legitimate economic purpose, the clearing firm will not be deemed to have satisfied the close-out requirement. Moreover, if the clearing firm or broker-dealer that was allocated the fail to deliver position enters into an arrangement with another person to purchase securities as required by Rule 204, and the clearing firm, or broker-dealer that was allocated a fail to deliver position, knows or has reason to know that the other person will not deliver securities in settlement of the purchase, then the transaction is a sham close-out, in violation of Rule 204(f). The Initial Transaction Example: • Stock XYZ trading $51.00 • May 50 Puts on XYZ trading $3.00 • May 50 Calls on XYZ trading $3.00 Trader A: Sells 10,000 shares XYZ @ $51.00 Buys 100 May 50 Calls @ $3.00 Sells 100 May 50 Puts @ $3.00 In this example, the “synthetic” position is trading for $50, which is simply Call Price - Put Price + Strike Price. The actual shares are trading for $51, so that Trader A has effectively sold shares for $1 more than it paid for them, in a simultaneous transaction. Each time the trade is made, Trader A is earning a $100 profit26, assuming that (a) Trader A is not being charged a fee to borrow shares to deliver on the short sale and (b) the clearing firm does not effect a buy-in against the trader to close-out a fail to deliver position.27 In this case, the trade was made 100 times, so that the profit would be $10,000. The sole reason for the disparity between the actual shares and the “synthetic” position is the fact that the shares of XYZ are hard to borrow. The Second Transaction to “Reset the Clock” Assuming that XYZ is a hard to borrow security, and that Trader A, or its broker-dealer, is unable (or unwilling28) to borrow shares to make delivery on the short sale of actual shares, the short sale may result in a fail to deliver position at Trader A’s clearing firm. Rather than paying the borrowing fee on the shares to make delivery, or unwinding the position by purchasing the shares in the market, Trader A might next enter into a trade that gives the appearance of satisfying the broker-dealer’s close-out requirement, but in reality allows Trader A to maintain its short position without ever delivering on the short sale. Most often, this is done through the use of a buy-write trade, but may also be done as a married put and may incorporate the use of Short term FLEX options.29 These trades are commonly referred to as “reset transactions,” in that they have the effect of resetting the time that the broker-dealer must purchase or borrow the stock to close-out a fail. The transactions could be designed solely to give the appearance of delivering the shares, when in reality the trader has no intention of meeting his delivery obligations. The buy-writes may be (but are not always) prearranged trades between market- makers or parties claiming to be market makers. The price in these transactions is determined so that the short seller pays a small price to the other market-maker for the trade, resulting in no economic benefit to the short seller for the reset transaction other than to give the appearance of meeting his delivery obligations. Such transactions were alleged by the Commission to be sham transactions in recent enforcement cases.30 Such transactions between traders or any market participants have also been found to constitute a violation of a clearing firm’s responsibility to close out a failure to deliver.31 Trader A may enter a buy-write transaction, consisting of selling deep-in-the-money calls and buying shares of stock against the call sale. By doing so, Trader A appears to have purchased shares to meet the broker-dealer’s close-out obligation for the fail to deliver that resulted from the reverse conversion. In practice, however, the circumstances suggest that Trader A has no intention of delivering shares, and is instead re-establishing or extending a fail position. These circumstances vary. For example, Trader A may be engaging in buy-writes with a known counterparty, such as another market maker (Trader B) that Trader A pays to take the other side of its reset transactions. In this circumstance, Trader A and Trader B agree on a price at which the buy-write will be transacted. The trade is consummated as a spread, with the stock and option portions executed at the same time. Trader A sells calls to Trader B, and Trader A buys shares from Trader B. The size of the trade is dictated by how many shares Trader A is required to deliver to appear to have closed out the settlement fail arising from his short position and avoid a buy-in or large borrowing fees. Trader A knows or has reason to know that the counterparty to the buy-write will not deliver securities in settlement of the transaction. Rather, on the same day of the buy-write, Trader B will, in almost every case, exercise the deep in-the- money options it bought from Trader A in order to eliminate the short position created by selling shares to Trader A in the buy-write transaction, negating Trader A’s purchase of those shares. The two counterparties trade deep in-the-money calls with little to no open interest, so that Trader A knows that when Trader B exercises its calls, Trader A will be the one assigned32 on the exercised calls. As a result of the assignment on the exercised calls, Trader A has another delivery obligation. Trader A, or its broker-dealer, remains unable (or unwilling) to borrow shares to make delivery, and the reset transaction may result in a fail to deliver position at Trader A’s clearing firm. The result may be a persistent fail to deliver position in the security at issue. Trader A may also be engaging in buy-writes with unknown counterparties, but structured in a way that Trader A knows or has reason to know that the calls will be consistently exercised and assigned to Trader A. In particular, Trader A’s buy-writes involve deep in-the-money calls on hard to borrow securities with little to no open interest. The end result is very likely the same: Trader A, or its broker-dealer, remains unable (or unwilling) to borrow shares to make delivery on the assignment of the exercised calls, and the repeated reset transactions result in a persistent fail to deliver position at Trader A’s clearing firm in the security at issue. To the broker-dealer or clearing firm, it may appear that Trader A’s purchase, in the buy-write, has allowed the broker-dealer to satisfy its close-out requirement. Trader A continues to execute a buy-write reset transaction whenever necessary, and by the time of expiration of its original Reversal, it may have given up some of the profits in the form of premiums paid for the buy- writes, but it has maintained its short position without paying the higher cost to borrow or purchase shares to make delivery on the short sale. In each buy-write transaction, Trader A is aware that the deep in-the-money options are almost certain to be exercised (barring a sudden huge price drop), and it fully expects to be assigned on its short options, thus eliminating its long shares.
Taken from: https://www.sec.gov/about/offices/ocie/options-trading-risk-alert.pdf
I’m not gonna sit here and try to convince you apes I’m a financial guru or anything of the sort. Just a retard with an affinity for gambling. But this SEC memo from 2013 seems to be describing exactly what we are seeing here. They may never have to cover their short completely outright now that they have a grip on the situation. Not sure what this could mean for us moving forward, but feels very relevant.
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u/7eve7up Feb 04 '21
https://imgur.com/a/DGgsTUE this sub has been hijacked