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JLN Options: Options Week in Review March 7, 2013

Bank of America bought 150,000 shares of Constellation Brands, a wine and beer seller, a few days before Constellation announced an acquisition in which the bank was the lead lender, The Wall Street Journal reported.  The bank made a big profit from the trade, which helped push the volume in the beverage maker’s options to more than 13 times the average volume of the previous 30 days. Bank of America said that in addition to the call position, it also bought put options on 133,100 Constellation shares as part of a directionally neutral strategy. However, the bank’s loss from the puts would have been tiny compared to its profit from the calls, the Journal said. A BofA spokeman said, “We have no reason to believe there was any sharing of inside information” between the investment bankers who financed the deal traders who made the options trade.

The SEC plans to call for the first update of automation principles in 22 years, according to a Bloomberg story. SEC commissioners were set to vote Thursday on the update, which would affect self-regulators, dark pools, and some networks that provide quotes and trade data to the public. They would be required to audit their information systems regularly and notify the SEC of any disruptions.

Trading in derivatives contracts based on the VIX was up in 2012 compared to 2011, even though the global economy showed signs of improvement, FinCAD Derivatives News reported.   A lower VIX reading – meaning less volatility — could generate benefits, including a rise in IPOs, according to MarketWatch.

ISE‘s filing with the SEC to launch a second options exchange, tentatively called “Topaz,” was published for comments in the Federal Register. ISE said it plans to launch the exchange in Q2 2013, pending SEC approval.   The new exchange, which would be the 12th U.S. equity options exchange, would have a different fee structure and would be differentiated in additional ways, ISE said.

Thirty-one organizations stated their intent to submit a bid for creating and maintaining a Consolidated Audit Trail (CAT) for all stock and option transactions in the U.S., Securities Technology Monitor reported  Former SEC chairman Mary Schapiro first proposed the creation of a CAT in 2010, after the May 6 “flash crash.”

On March 18, long-time rivals ISE and CBOE will launch competing mini options contracts, FOW reported. NYSE Arca Options will also begin trading the mini contracts that day. The contract size will be 10 shares of the underlying, one-tenth the size of the regular options. They are designed to give retail and other investors the opportunity to trade options at a much smaller price.

The Shanghai Stock Exchange plans to launch options for individual stocks this year, offering investors a new way to manage risks in or profit from China’s volatile stock market. The move is part of China’s efforts to widen its domestic market by offering a range of financial instruments, according to the Wall Street Journal.

In his annual letter to shareholders, Berkshire Hathaway CEO Warren Buffett discussed his belief that stock options will be even more profitable in the future, calling into question whether the entire market for options is mispriced, according to the Motley Fool. In a previous shareholder letter, Buffett had described the pricing inefficiencies of the options market and how he planned to exploit them. The problem is with volatility assumptions made under the Black-Scholes model, which can get “baked into” options prices over shorter periods of time, when stocks can move abruptly.  However, over longer periods, stock market returns have been smoother, so the Black-Scholes model ends up valuing options too highly, the Fool said, paraphrasing a blog post by Barron’s reporter Brendan Conway.

OCC announced today that total cleared contract volume in February reached 325,237,351 contracts, representing an 8 percent decrease from the February 2012 volume. OCC’s year-to-date cleared contract volume was up 0.19 percent from 2012 with 690,265,229 contracts.

CBOE said it would move its new SPXpm contract from its all-electronic C2 exchange into the open outcry pits after the contract failed to generate much volume. Many in the industry had thought the pm version of the SPX options would be a huge hit, because the CBOE was offering automated executions in an index option based on the S&P 500 for the first time, Traders Magazine reported. CBOE execs said they believed that the Weekly SPX contract that began trading electronically at CBOE at about the same time stole the pm contract’s thunder.

ISE reported that it was the largest equity options exchange in February, with a market share of 18.1, excluding dividend trades, which made up 4.4% of industry volume that month.

CBOE Holdings said the cost of resolving a yearlong regulatory investigation could be as high as $10 million, double what the company has set aside to settle the matter, according to a regulatory filing. For more than a year, the SEC had been looking into the way CBOE regulates firms that do business on its markets as well as on other exchanges. The investigation stemmed from alleged violations of securities laws by a unit of the Chicago firm OptionsXpress, Dow Jones reported.

— Sarah Rudolph

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