The War Over The $1,520 Gold Pin Tomorrow - Part 3 Of "Market Manipulation: A Recipe in Three Parts"

Tyler Durden's picture

From FMX Connect, which continues its very educational and highly informative series about precious metals price manipulation and interference. Previously: Options Risk, Manipulation, And The May Silver $40 Calls: An FMX Connect Special - Parts 1 And 2

Summary: Right now there is a war in Gold options. It is between the May 1520 longs, who most likely are unhedged, and their short option counterparts, who most likely are hedged. One would think the longs intend to sell futures at some point, perhaps 1520, perhaps 1540 we do not know. It is also possible that they intend to take delivery, but that is unknowable for the moment. The shorts are probably delta hedgers and have no desire to see this market go above 1520, much less move at all.

Full report:

Overview

Price Manipulation and its cousin
“mismarked books” are as much a product of systemic dysfunction as they
are of unethical individual behavior. The 3 part series we have planned
is educational in nature and aims to outline those system-wide
imperfections at the highest level. For today we must focus on what is
shaping up to be a rare opportunity to watch a pitched battle between
major players in Gold. In short, we are interrupting your regularly
scheduled program.

Current Events: The Potential Pin in Gold Options Tommorow

Right
now there is a war in Gold options. It is between the May 1520 longs,
who most likely are unhedged, and their short option counterparts, who
most likely are hedged. One would think the longs intend to sell futures
at some point, perhaps 1520, perhaps 1540 we do not know. It is also
possible that they intend to take delivery, but that is unknowable for
the moment. The shorts are probably delta hedgers and have no desire to
see this market go above 1520, much less move at all.

The Players

  • The Longs-
    have accumulated over 5,000 lots in a two week period and we would
    assume they are bullish. They are patient dip buyers and seem to have
    little fear of the Bullion Banks that are often accused of manipulating
    PM prices lower or keeping prices range bound at expiration.

 

  • The Shorts-
    are Bullion Banks, market-making firms, locals and possibly some hedge
    funds. There is no collusion implied here. In fact, these firms are
    usually at odds with each other in terms of option open interest. The
    majority of the shorts trade options from a non-directional point of
    view. That is, they are professionals who, when short an option do not
    want the market to move either way. Conversely, when they are long an
    option, they want the market to move quickly through or away from the
    strike they own.

The Play
We
feel the Longs were betting that once the gravitational pull of the
$1500 strike was broken, that the market would move quite easily to the
strike with the next largest open interest, the $1520 strike. They may
be privy to large order flow in futures, they may have large futures
order flow, or they may simply be speculating with nothing other than
their wallets and the ability to read market behavior through price
action. They can spot a market that is lopsided in one direction when
they see it.

Snapshot: May Gold Open Interest

product

contract

type

strike

volume

open interest

OG

May-11

C

1480

598

2303

OG

May-11

P

1480

368

675

OG

May-11

P

1485

271

341

OG

May-11

C

1485

11

666

OG

May-11

C

1490

5

970

OG

May-11

P

1490

379

416

OG

May-11

P

1495

86

280

OG

May-11

C

1495

35

361

OG

May-11

C

1500

211

6762

OG

May-11

P

1500

445

522

OG

May-11

P

1505

17

333

OG

May-11

C

1505

76

306

OG

May-11

C

1510

507

1731

OG

May-11

P

1510

344

116

OG

May-11

C

1515

116

1374

OG

May-11

C

1520

580

5823

OG

May-11

C

1525

143

747

OG

May-11

C

1530

128

578

OG

May-11

C

1535

95

289

OG

May-11

C

1540

9

730

OG

May-11

C

1550

40

1570

OG

May-11

C

1600

26

1515


The Next 48 Hours
We have alerted the reader to this possibility for the past week. All that remains is this:

Today the LME is closed
This
deprives the market of a deep source of liquidity. While the LME
Players are surely watching and trading today, we suspect the “A’ teams
may not be, however, as holiday continues for many and trading at 9PM
London time is not very fun if you are an MD at a large Bank. Also
remember there was no LME fix today, which has an effect on balance
sheets for London firms. No London Fix, no Balance Sheet Axe, so to
speak.

Tomorrow Comex Options Expire

If
the Option Longs are right, then the market will be propelled through
the 1520 strike. Futures should receive additional support at some point
from the negative gamma hedging of those non-directional players who
MUST adjust their delta hedges.  The longs are playing for a longer time
line than the shorts in this instance.

If
the Option Shorts win this battle then we will pin the strike.
Remember, a violent sell-off is not good for the shorts either. A pin
means the options go out worthless theoretically, and the future hedges
that longs carried against those shorts can be liquidated for a profit.

Let’s
assume next that the Options Shorts “win” this battle and through hope,
prayer, or their own attempts to keep the market in a range, the $1520
strike is Pinned or near-Pinned on the closing bell at 1:30 PM ET
tomorrow.

The Pin
If
a Pin occurs, the longs have another two and a half hours to decide if
they wish to abandon or exercise their calls. They own the optionality
at the strike. The option shorts can still lose a lot of money, even if
the option longs make none. A sell-off is very possible, wherein the
option longs abandon their calls, but the option shorts still have
hedges to unwind. The Shorts would be forced to use statistical methods
to determine if they will get exercised or not. More than likely this is
a digital event, and statistics do not matter when most of the
contracts are in the hands of a single player or a group of like minded
players, as may be the case here. We are likely looking at an
all-or-none exercise if we pin the strike. The shorts would be in the
dark.


Manipulation in the Commodities Market
A
multitude of individuals and firms have been accused of market
manipulation, over the years. Many individual traders have been brought
to task for their actions. The Hunt Brothers attempt to corner Silver,
Yasuo Hamanaka of Sumitomo for his copper manipulation in 1995, by,
various “rogue’ traders and brokers and most recently, the CFTCs
successfully prosecuted of a case involving Brian Hunter of Amaranth for
his actions in the natural gas market. Nonetheless, very few firms have
suffered commensurately.

Business as Usual
Firms
that have been successfully prosecuted continue to operate in the
markets they have manipulated, usually with monetary wrist slaps. To be
fair, major firms settle disputes all the time, but the fines are not
proportional to their balance sheets when compared to the individual
fines; nor are the firms’ abilities to go back to business-as-usual in
the market place affected.

It’s Baked in the System
We
believe manipulation is a product of many things, and attempt here to
boil them down to three broad categories. First, the U.S. Government’s
accounting and regulatory policies unintentionally enable these events
to occur. Second, the rights accorded corporations give them the ability
to mandate profits above all else, all the while getting the same
privileges an individual person does. Companies have no social contract
and their goal is to continue to exist, a combination easily misused.
Finally, market structure, especially in commodities lends itself to a
tail wags the dog situation wherein the transparent pricing mechanism
for settling contracts is not where most of those contracts actually
trade. This results in a disconnect between liquidity and price that can
lead towards “managed market” abuses.

We
intend over the next week or so to outline at the highest levels how
government policies, corporate mandates, and market structure contribute
to the moral hazards in derivative markets.


For today and tomorrow, we will just be watching the Precious Metals markets like we suspect many of you will. Good Luck.

Read full report below (PDF)

Market Manipulation Part 3