INSUBCONTINENT EXCLUSIVE:
Jane Street Group LLC, a US-based global proprietary trading powerhouse, which allegedly manipulated the Indian derivatives market, employed
a strategy called 'Marking the close' on the Nifty index options.Here is a 5-point explainer on how this strategy works and why it is
illegal:1) Any option contract has an underlying stock, and its premium moves with the price of the underlying stock
For Instance, HDFC Bank's CALL option premium will rise if the stock price of HDFC Bank rises while its PUT option premium will rise with a
fall in its price.2) The logic can be extended to the index options, too
For instance, if the Nifty index moves higher, then the Nifty CALL option premium increases and the same is the case with the Bank Nifty
For index options, the underlying is the index itself, which in turn is a basket of stocks.3) How Options premiums work
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Strike price is the price at which you exercise the option.So Premiums are high when they are at-the-money or in-the-money.-- In-the-money
(ITM) call option: Current price is higher than strike price-- In-the-money put option - Current price is lower than strike price--
At-the-money (ATM) call/put option: Current price is close to strike price4) On expiry days, OTM (Out of the Money) options are cheap
because they are likely to expire worthless
ATM options are most volatile because they near the strike price and anything can happen
But for ITM options, they are fully loaded and available at a premium.Read More: Sebi may widen Jane Street probe to other indices,
exchanges: ReportFor an options trader, the catch lies in the transition of premiums if he can buy a cheap OTM option for 50 paisa or a
rupee and then watch it grow to Rs 10, 20 or even 100 in a matter of a few hours
Traders with deep pockets can make this possible and Jane Street's deep pockets seem to have that kind of money.5) On the expiry day, you
buy all the cheap Index OTM options on one hand and on the other hand, you either buy or sell the index underlying constituents to an extent
where the options start to move in your favor
Sophisticated traders can do it by just buying or selling heavyweight stocks of the index.Traders can buy all the cheap options before 3 pm
and after that, they can accordingly make orders worth crores of rupees in the heavyweight stocks.It can be done through algorithms which
know the exact quantity, price and time, which makes computation of the expiry closing price easy, as the closing price is the weighted
average of the last 30 minutes.The algorithms know the closing price which in turn makes your position favourable.Also Read: Jane Street
Fallout: Zerodha's Nithin Kamath flags risk to brokers and stock exchangesWhy is it illegal?Market regulator Sebi holds this as an unfair,
deceptive, and manipulative practice that violates its norms.Sebi's 105-page order holds that Jane Street made unlawful gains through this
Jane Street has refuted these allegations and has said that it will engage with the regulators.(Disclaimer: Recommendations, suggestions,
views and opinions given by the experts are their own
These do not represent the views of Economic Times)
