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Options Risk, Manipulation, And The May Silver $40 Calls: An FMX Connect Special - Parts 1 And 2

Tyler Durden's picture


From Vince Lanci of FMX Connect

Options Risk, Manipulation, and the May Silver $40 Calls

The purpose of this series is to help the
reader better understand the risks and pitfalls of trading options and
having a position at expiration. We will try to describe exactly what
happens at expiration. The concepts here apply to all options markets,
but we chose to focus on Silver because an interesting expiration is
setting up presently. The upcoming expiry gives us an opportunity to
discuss all the pieces of the option puzzle: the Greeks, market
manipulation, Pin risk, and other factors.

Lesson #1

futures markets where major participants are absent, options players
dictate market movement for short periods of time. During this time the
market may flat line, or it may have large, impulsive moves in either
direction. What happens is determined by the strong-handed player, and
sometimes his inclination to “game” the market.


The Easter Egg

Observe if you will, the 6 days prior to expiration of Comex May Silver options.


April 21st, Holy Thursday: day before a holiday             

April 22nd: Good Friday:  CME Closed

April 23rd,Easter Saturday:  Markets Closed

April 24th,Easter Sunday: Markets Closed

April 25th, Easter Monday:  LME Closed (Largest Physical Bullion Exchange Worldwide)

April 26th, Tuesday:  May Options Expiration CME


may ask, what does the above imply? The above implies that normal
liquidity will not be present for the last 5 days before expiration.
Sunday Evening US time is usually quite liquid during London hours, but
will not be this week. Monday will also be a liquidity ghost town, as
LME players will be out. It is doubtful that many US futures liquidity
providers will be in the day after Easter either. This is a market ripe
for an event.


this week and next, we will attempt to break down the factors
influencing the outcome of this expiration as a proxy for understanding
commodity options risk in general. It will include:

·         The players and their biases

·         Option Greeks demystified

·         How to spot when a market is ripe for “management”, like above.

·         Regulatory factors enabling this behavior.

Part 2: A Zero-Sum Game

any single trade, the option buyer and seller are fundamentally at
odds. Both types of player (referred to as options long and options
short) make their money in opposite ways, and at the expense of the
other. The long players expect to make more money scalping Gamma than
they lose in Theta over the option’s life. The Short players bet that
the Theta they collect will outweigh the market movement and the
negative Gamma they incur, most poetically described as “wishing for

To understand how and why markets sometimes get
“managed” at expiration it would make sense to first understand the
Option Greeks. This combined with who the players actually are, and
understanding the regulatory inconsistencies will tell the full tale on
why markets are ripe for manipulation near options expiration.


Keeping Score

Options risk is a complex task. We are going to focus here on only
three of the “Greeks” used to quantify and manage risk, Delta, Gamma,
and Theta. These are the most important ones affecting an option
trader’s behavior as expiration approaches and the market is hovering
near a strike. We’ll attempt to explain them plainly and simply through
examples. For these explanations we must assume that all other Greek
parameters: like volatility, rho, etc remain static to better isolate
the effects of delta, gamma, and theta on risk.



In physics Delta means rate of change. In calculus Delta is the tangent of the trajectory.  But
Delta actually has 3 definitions in the practical trading world. These
definitions largely overlap but are not necessarily the same for the
whole life of the option.

1.      Correlation with the underlying:
a Call has a 20 delta. The model generating that delta assumes the
Call’s value will change by 20% of what the underlying changes. E.g. Crude Oil goes up by $1.00. The Call will go up by $0.20 assuming other Greeks remain the same.

2.      Hedge Ratio: The long 20 delta call would be directionally neutralized if it had a hedge of short 0.20 futures per long options contract. E.g.
I am long 100 Crude Oil calls with a 20 delta. I will sell 20 futures
to hedge myself directionally. Therefore I will (theoretically) neither
make nor lose money in either direction due to underlying movement. I am
directionally “flat”

3.      Probability of Expiring in-the-money:
according to the model, said 20 delta call has a 20% chance of expiring
in-the-money. e.g. an option with 30 days to expiry at this volatility
has an implied probability of a 20% chance of expiring in-the-money.[1]


Gamma is the second derivative of the option. In physics, it is the rate-of-change of
the rate-of-change. In calc it is the tangent of the velocity. For our
purposes it is simply how much a delta itself will change (Correlation,
Hedge ratio, or Probability), given a change in the underlying price.

our Crude Oil 20 delta call option again: Crude rallies from $90.00 to
$91.00. In our example, the option has a 20 delta and its
correlation/hedge ratio/probability all point to a change in the
option’s value of $0.20. But that cannot be entirely correct if one
measures the option’s value at the end of the $1.00 move in crude.

the market has moved higher, the option has an increased probability of
going in the money. Therefore its Correlation, Hedge Ratio and
In-The-Money Expiration Probability must increase. In our example, we
use our model to re-calculate the delta of the call and find that its
delta has gone from 20 to 25. This difference of 5 deltas over a $1.00
move is its Gamma.


we now have the ability to sell 5 more futures against our 100 calls if
we wish to rebalance our directional risk. We get to “Sell High”. And
if the market drops back down to $90.00, the option’s delta will once
again become 20. We will get to “Buy Low”. Such is the virtue of being
long Gamma. The ability to sell when something goes up, and buy it back
when it comes down. Provided of course your model is right, and as we’ve
said multiple times other Greeks don’t change. Gamma however comes with
a cost called Theta.



rate at which an out-of-the-money option loses its value over time is
Theta. In short, it is the rate at which your long lottery ticket wastes
away. As time goes to zero, your out-of-the-money option’s chances of
expiring in the money go to zero as well.  It is
not unlike having tickets to an event that you wish to sell. If interest
is tepid in the event (Jethro Tull : Bore ‘em at the Forum) and you
can’t get face value for them from someone, you are said to be
out-of-the-money. You will lower your price as we get closer to the
event itself in the hopes of unloading them. That is an imperfect
example of Theta.

our 20 delta call again: if it has a Theta of .05. That means it will
lose 5 cents of value per day from the march of time, again assuming all
those other Greeks we are not talking about remain the same. So as a
holder of that Crude Oil call with a 20 delta, you are in a race against
time. If you cannot make more than 5 cents per day from delta
readjustments (aka Gamma) after the underlying moves, you will be a net
loser of money. Put another way, you must “scalp your Gamma” to profit
by 5 cents daily just to break even on your option investment. More than
5 cents and you profit, less than that and you lose.


Options Yin and Yang

and Theta are opposite sides of the same coin. These risks and how they
are managed by opposing counterparties, combined with the asymmetric
setup in the system are the key to the reasons for why so many option
expirations get “pinned” at a strike with large open interest. And also
why rarely but more sensationally, markets blow through strikes with big
open interest.

[1] So,
we can say that given no changes in implied volatility or any other
Greek, and assuming that markets are random in their movement 100% of
the time, that information is disseminated in these markets
instantaneously, and finally that liquidity is deep and continuous in
the option itself those 3 definitions above should overlap 100%.

we know that none of the above is true, that markets are not efficient
and that the playing field is not level due to economic, regulatory, and
technological differences in participants. This is over and above the
different skill of players involved.


the Author: Vincent Lanci is a 22-year veteran of the commodity option
markets. He started on Wall Street at Lehman Brothers and is a former
floor trader and energy fund manager. He currently manages Echobay
Partners, a private equity firm specializing in commodity and exchange
related investments.



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Tue, 04/19/2011 - 17:43 | 1185831 Robslob
Robslob's picture

Where are the cliff notes?

Tue, 04/19/2011 - 18:26 | 1185953 VogonPoet
VogonPoet's picture

I blurred at Correlation with the underlying. This is an interesting post for the layman who actually cares (like me), but Damn! this is a hard read at the end of the day. I hope I remember to revisit in the morning when i have more energy and better focus.

Tue, 04/19/2011 - 19:04 | 1186052 Doña K
Doña K's picture

My hubby told me that to make money on options, you have to be lucky, directionally correct and buy them deep into the money.

Now I don't know what that means. But I know that my hubby is very smart. He bought me my first Porsche shorting Bear Sterns.

Wed, 04/20/2011 - 00:23 | 1186951 ShittyLipsMcCra...
ShittyLipsMcCrapStain's picture

What an annoying fucking bot you are....

Wed, 04/20/2011 - 12:04 | 1188468 French Frog
French Frog's picture

i eagerly await part3-4... for your prediction regarding the movement of silver before expiration next week

Tue, 04/19/2011 - 20:09 | 1186294 slewie the pi-rat
slewie the pi-rat's picture

hey, robslob, no prob, happy to share! wld you like the cliff notes for Pt. 1 or Pt. 2?

Tue, 04/19/2011 - 17:56 | 1185881 rumblefish
rumblefish's picture

does options expirations have anything to do with SLW being down while silver was up over the last few days?

Tue, 04/19/2011 - 18:00 | 1185900 ZeroPower
ZeroPower's picture

Might have until last friday (OpEx), but would have had to see where the majority of the OI in the strikes was. Next monthly equity OpEx is May21.

Tue, 04/19/2011 - 18:52 | 1186012 Protonrick
Protonrick's picture

SLW's CEO unexpectedly resigned effective last Tuesday.  Sure looks like somebody knew that the day before, however.  A bear pennant resolved to a lower gap fill, and now the stock is back in action.  IMHO 

Tue, 04/19/2011 - 17:55 | 1185884 Dingleberry Jones
Dingleberry Jones's picture

Beautiful job. Seriously, many thanks.

Tue, 04/19/2011 - 17:58 | 1185892 NOTW777
NOTW777's picture

good stuff - always learning

Tue, 04/19/2011 - 17:59 | 1185893 ZeroPower
ZeroPower's picture

Good options101 intro, but nothing here on the SLV manipulation, im guessing more posts are coming this week?

Tue, 04/19/2011 - 18:04 | 1185905 NOTW777
NOTW777's picture

how do we know for sure that "major" participants are absent in futures??

Tue, 04/19/2011 - 20:42 | 1186373 HK
HK's picture

Here's an interesting article that surmises that major participants are usually present:



Tue, 04/19/2011 - 21:58 | 1186549 Pegasus Muse
Pegasus Muse's picture

+100 Great article.  Hoffman explains with great clarity the government's manipulation of the markets, particularly the gold and silver mining stocks.  Watching how the miners have behaved the last two weeks it is intuitively obvious what Hoffman says is the truth.

Tue, 04/19/2011 - 18:04 | 1185908 Bastiat
Bastiat's picture

A $4 (10%) takedown in a thin market into OPEX.  Entirely possible.  But it won't last long as the Asians BTFD.  There is also the matter of delivery in May . . . and the physical supply/demand function that just won't go away. 

Tue, 04/19/2011 - 18:33 | 1185963 macholatte
macholatte's picture

There is also the matter of delivery in May . . . and the physical supply/demand function that just won't go away. 


This is a serious question: say I buy one June silver contract (to get away from the theme of the article) and about a week before expiration I tell my broker I want to take delivery. What happens next (please answer in these 2 scenarios):

scenario #1: normal supply, no problems with delivery (circa 2005)

scenario #2: supply compromised (problems of today)

Has anyone done this recently?


Tue, 04/19/2011 - 18:49 | 1186003 malusDiaz
malusDiaz's picture

Step 1: They take your money.

Step 2:  "Magic Happens"

Step 3: PROFIT!


-Otherwise known as: Your silver is delivered to a JPM Registered vault (along with UoT gold) where you are not allowed to withdrawal it for national security reasons.

Tue, 04/19/2011 - 19:54 | 1186246 fmxconnect
fmxconnect's picture

1- you declare intent to take delivery

2- your clearingfirm tells the exchange on first notice day

3- they start to hound you for the face value money to pay for it.

4- they ask if you want to keep it in the vault or do you want it delivered


scenario 1- see above


scenario 2- does not exist yet. you can take delivery of bars anytime you want. but if it did the exchange would find a short like in scenario 1 and tell him he must either reissue or make delivery. if he didn't have the metal he'd lease it form someone else to make delivery or  cover the short contract or roll the short back deferring delivery. Enough deferring and contango becomes backwardation as we have today. if there was noone who wanted to make delivery then the market would rally on short covering.


If there was no physical to back the contract, the contract would be broken.Google Potato contract on Nymex back i nthe day.

most likely, the govt would step in declare crisis, suspend delivery, make everyone settle in cash and the contract would continue to trade. Albeit at a discount to real silver



Tue, 04/19/2011 - 23:49 | 1186859 macholatte
macholatte's picture

thanks for the help.

next question is how to get protection from a broken contract, is there insurance available?

It would be interesting indeed if a single individual who wanted to take delivery, put the goods on his own truck and not leave it in the JPM vault in return for a receipt (JPM fiat) caused the kind of market disruption you outline above.

Tue, 04/19/2011 - 18:10 | 1185922 Math Man
Math Man's picture

The theta decay won't matter any  more when silver breaks $40 later this week...  this bubble has gotten out of hand.  It only costs $5 bucks to dig it out of the ground.




Tue, 04/19/2011 - 18:15 | 1185929 Bay of Pigs
Bay of Pigs's picture

And of course, you can't eat it either.

Tears of the Moon Mathboy...

Tue, 04/19/2011 - 18:20 | 1185938 akak
akak's picture

It only costs $5 bucks to dig it out of the ground.

And there's only about $3000 worth of actual physical materials in a new $35,000 pickup.  So I am going to immediately go to my nearest truck dealership and demand that they sell me a brand new pickup for $3000.  Thus dictates the logic of MothMan.

Tue, 04/19/2011 - 18:22 | 1185945 malusDiaz
malusDiaz's picture

And plants grow in the sunlight for free!

Chickens pop eggs out and you don't have to pay them either!

WTF!  I Demand my free food!


Tue, 04/19/2011 - 18:33 | 1185965 Burnbright
Burnbright's picture

lolz, you win. 

Tue, 04/19/2011 - 18:59 | 1186046 iowaguy
iowaguy's picture

Don't forget that any money from the government is free money.

Wed, 04/20/2011 - 02:29 | 1187104 Hephasteus
Hephasteus's picture

Why does it cost 7 cent's to make a nickel?

Because it costs 12 cents to make a 100 dollar bill!!!!!

Wed, 04/20/2011 - 01:36 | 1187060 Dr. Porkchop
Dr. Porkchop's picture

If you had the parts and brought a team of 10 autoworkers to your home shop; do you think they would be able to assemble the truck?

Tue, 04/19/2011 - 18:32 | 1185962 rumblefish
rumblefish's picture

if thats true, you should be buying SLW in addition to physical. A whole lot of FRN's wil be coming their way.

Tue, 04/19/2011 - 18:32 | 1185968 ssp2s
ssp2s's picture

Meth is back!  Your return is a major buy signal.  $50 apparently is on the way.

Tue, 04/19/2011 - 19:24 | 1186145 stephysat28
stephysat28's picture


Wed, 04/20/2011 - 01:07 | 1187019 quartshort
quartshort's picture

Ok you dumb bastard ass... Here is five fun tickets courtesy of Ben. Start digging. When you get to six feet quit, and and proceed in reverse from the bottom. This makes about as much sense as your dumb fucking comment above. Personally, I'm praying for the miner trapped over the hill here in Idaho, but I assume you have rolled that one into your feeble calculation. Using the ass cracker's logic I can go outside and put a five dollar butt wipe in my back yard and PoOf... an ounce of silver will appear. Damn it. I just spent ten mintes on my turd phone just to reply to this shit. Worth every second.

Wed, 04/20/2011 - 03:19 | 1187145 Dr. Porkchop
Dr. Porkchop's picture

Try not to get too worked up. He's just a troll. He probably doesn't even believe his own bullshit. He's just here to agitate people, as trolls do.

Tue, 04/19/2011 - 18:12 | 1185923 gwar5
gwar5's picture

Good stuff. I think I grew more hair on my synapses. I'm good holding physical metal. Playing the game is a fun and gets the adrenaline pumping, but not for me anymore. I mostly got out of the market in Nov 2007. Just rode it down with short ETFs.

Much more fun and liberating being out of the banking system and going John Galt, going dark. No thinking about capital gains on transactions. Just watch PMs and a few other hard assets do well. 

In psychology, this "rate of change of the rate of change," is called stepping on the Happiness Accelerator

Galt out.



Tue, 04/19/2011 - 20:43 | 1186374 slewie the pi-rat
slewie the pi-rat's picture

yay for gwar5!!!  yay!  will be self-medicating in yer honor, tonight!

Tue, 04/19/2011 - 18:40 | 1185987 NotApplicable
NotApplicable's picture

So, where's the $40 May silver calls example?

Did somebody fat-finger the copypasta?

Tue, 04/19/2011 - 19:42 | 1186215 fmxconnect
fmxconnect's picture

part 1 implies if we are near the 40 strike come next Tuesday, watch out.

we'll get more specific on the how in subsequent parts.

Tue, 04/19/2011 - 20:25 | 1186329 slewie the pi-rat
slewie the pi-rat's picture

9% correction, we're there!  

i think if the beta gets the delta goin, the gamma and theta will just rock!  

does silver even have a beta?  i'm not sure.  if it doesn't, slewie will give it one.  how about 70?

Tue, 04/19/2011 - 18:50 | 1186007 Cow
Cow's picture

Great stuff.  This is easily the best website on the web.  I'm sending them some money.  


Tue, 04/19/2011 - 18:58 | 1186039 Theta_Burn
Theta_Burn's picture

Suffering the burn as we speak...

Nice piece

Wed, 04/20/2011 - 01:39 | 1186104 swissinv
swissinv's picture


Tue, 04/19/2011 - 19:16 | 1186108 Bubbles...bubbl...
Bubbles...bubbles everywhere's picture

Dog gone it...I knew I should have joined a fraternity in college.

Tue, 04/19/2011 - 21:47 | 1186518 bigdumbnugly
bigdumbnugly's picture

yeah, trust me bubbles, that didn't help...

Tue, 04/19/2011 - 19:28 | 1186160 AboutAverage
AboutAverage's picture

Here is an option lesson.  Those who know the position balances and control the price - win 90% of time.    Those who have the government in their pocket and know balance positions and control the price - win 100% of the time. 

Life lesson - don't play a rigged game.   If you want to gamble, go to Vegas.  I read somewhere they are closing down online gaming - probably because the payouts are better than the Street.   Got to eliminate that competition!

Tue, 04/19/2011 - 19:56 | 1186256 fmxconnect
fmxconnect's picture

This is essentially Part 3. thank you for summing it up so neatly.

Tue, 04/19/2011 - 21:07 | 1186432 Theta_Burn
Theta_Burn's picture

Don't play a rigged game...amen

The destruction of my trading account this year was epic.


For those options trader out there, if you haven't seen this, its pretty cool

Tue, 04/19/2011 - 21:34 | 1186480 Pepe
Pepe's picture

i liked that;thanks

Tue, 04/19/2011 - 21:51 | 1186524 bulldung
bulldung's picture

+ 1, thanks for link

Wed, 04/20/2011 - 02:08 | 1187087 been there done that
been there done that's picture

This is REALLY GREAT!!! Thanks. I tried making one of these using a spreadsheet but you had to copy and paste options data. This ROCKS!!!!!!

Tue, 04/19/2011 - 19:43 | 1186210 fmxconnect
fmxconnect's picture

Banks will be in the markets, but their main traders, MDs and people in charge of risk will eb on vacation like other humans. the kids will be watching the fort. 

Tue, 04/19/2011 - 20:08 | 1186287 Carnegie_IB
Carnegie_IB's picture

when i leave the fort, i am certain not to leave anything of significant value there; espec, if i know the kids are watching the place. certainly the kids will trash the place while im gone in the meantime.

go long entertainment, short rational, perhaps even short theta just because it is not expected.

Tue, 04/19/2011 - 21:17 | 1186447 Pepe
Pepe's picture

it seems to me that lately the change in gamma as the underlying moves in the money affects the ask-bid spread the most, so one has to be a cherokee scalper to get ahead nowadays

Tue, 04/19/2011 - 21:36 | 1186479 Variance Doc
Variance Doc's picture

Great, more advice from a C- student in math.  "In calculus Delta is the tangent of the trajectory..."  No, it is not.  The "delta" is the SLOPE of the tangent.  It's easy to remember, it rhymes with dope. 

Also, physics is not the end-all, be-all of the rate of change or velocity market - calculus also interprets "delta" as a rate of change.

Gamma is known to physicists AND mathematicians as acceleration, and it is NOT known in calc as "... the tangent of the velocity..."  It is the SLOPE of the slope of the tangent, when the limit exists.

Let me know when you're done with your acid trip.

I need a shower after reading that....

Tue, 04/19/2011 - 22:02 | 1186562 Atlas Shrieked
Atlas Shrieked's picture

Not so quick, the slope is the tangent at point P, the first order derivative, the velocity in physics.  The 2nd order derivative is the slope of the slope, or the acceleration in physics.

Tue, 04/19/2011 - 22:19 | 1186599 Variance Doc
Variance Doc's picture

"...the slope is the tangent at point P..."  You guys have the same learning disability.  The derivative is the slope of the tangent line through point P.  The slope is NOT the tangent at point P.

As stated above, math considers derivatives as rates of change (inc. higher order) too and not just some geometry problem.

Mon, 04/25/2011 - 13:18 | 1204086 Atlas Shrieked
Atlas Shrieked's picture

uuummm, It's the instantaneous rate of change at any point in time that's relevant.  And it's an infinite number of slopes/tangents that define a curve.  The word "slope" is used interchangeably sometimes--correctly for static functions, and not so correctly for calculus.  So yeah, you're not statically connecting two points to define average velocity.  You're defining a function that describes the instantaneous velocity at any single point in time.

Tue, 04/19/2011 - 22:20 | 1186610 kubrick007
kubrick007's picture

this means there will be serious theta kick tomorrow morning to 4pm, and prob was today too but i missed it (like an idiot)...those short volatility should statistically make money on a day like tomorrow if they short theta in the morning and close positions before end of day.

jeff augen has a lot of excellent options trading books and one of them had a pretty large section devoted to this.

Wed, 04/20/2011 - 03:35 | 1187163 jmc8888
jmc8888's picture


...and it's all bullshit when it comes to investing.

Instead of learning this, mankind would be better off actually learning something useful like physics, thermal dynamics, etc.  Too bad business degrees force you into this crap. Of course by teaching it like it's god, and not the bullshit made up crap that it is.

It's really not that hard, but the key is to be able to do it in your head in your mental graphing area.  See the movemnt on the fly, and understand what changes these and alter the rates of change, since life doesn't correspond to the previous bullshit laced info it is derived from. (thus why blind faith in it will lead you astray) So again, our economic system would be better off ditching this crap and focusing on real tangible stuff using real mathematics.  Knowing this stuff, is just knowing the rules of a select game, that happens to excludes just about everybody, but affects everybody.

It is just sophistry filled bullshit that allows a bunch of the 'smartest people in the room' to rig the game beyond that of mere mortals to achieve their ends, not a real direction that takes us anywhere useful on a macro level, or for society as a whole.

That said, until it changes, it's useful to know on an individual level, given the reality of where and what bullshit system we live in.  Just understand, it's bullshit, like a game of monopoly, and counterproductive to what we really need to focus on and head towards.  Don't let it get to your head, because after all, it's bullshit. 


Wed, 04/20/2011 - 07:53 | 1187432 No Bid
No Bid's picture

So what you're saying is that it's all BS but you're really great at it, that it's something not many get but they should and you do, that [again] it's BS but affects everybody.


If finance is so useless [though you freely admit it affects everyone] than why don't you stop posting here and invent an airplane that runs on tea leaves.


Wed, 04/20/2011 - 07:49 | 1187423 No Bid
No Bid's picture

Fantastic Post.

Wed, 04/20/2011 - 16:15 | 1189729 Eric Cartman
Eric Cartman's picture

This is a hell of a lot easier to understand than TD's Intra Day Arb posts. 

Fri, 04/22/2011 - 11:01 | 1196109 epwpixieq-1
epwpixieq-1's picture

"a Call has a 20 delta" => f(x) or is a function of the underlying asset or whatever is there, could be just an illusion of an asset.
Note that this implies that "one knows what" f(x) is and, in my opinion, this is the most difficult part of the problem. Everything else can be burned via commodity microchips or, in order to run in front of everyone else, some customized application hardware architecture burned on FPGA.

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