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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Robslob's picture

Where are the cliff notes?

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.

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.

ShittyLipsMcCrapStain's picture

What an annoying fucking bot you are....

French Frog's picture

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

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?

rumblefish's picture

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

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.

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 

Dingleberry Jones's picture

Beautiful job. Seriously, many thanks.

NOTW777's picture

good stuff - always learning

ZeroPower's picture

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

NOTW777's picture

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

HK's picture

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





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.

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. 

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?


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.

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



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.

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.




Bay of Pigs's picture

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

Tears of the Moon Mathboy...

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.

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!


iowaguy's picture

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

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!!!!!

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?

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.

ssp2s's picture

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

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.

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.

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.



slewie the pi-rat's picture

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

NotApplicable's picture

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

Did somebody fat-finger the copypasta?

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.

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?

Cow's picture

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


Theta_Burn's picture

Suffering the burn as we speak...

Nice piece

Bubbles...bubbles everywhere's picture

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

bigdumbnugly's picture

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

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!

fmxconnect's picture

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

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 http://www.optionpain.com/MaxPain/Max-Pain.php

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!!!!!!