The Mind of an Independent

Yeah, I don’t think you should be too upset by this. First of all, I think what you’re trying to reference by the phrase “markets are supposed to reflect the wisdom of crowds” is the efficient-market hypothesis which is somewhat different than your “wisdom of crowds” thesis. Basically EMH states that a security’s price is a correct representation of value of that business, as calculated by what the business’s future returns will actually be. Crowds are not a good indicator of wisdom, but I’d argue that options are; or at least a good indicator or where the future price of an asset may be heading.

I’ll try not to get too boring, but let’s take the J Crew (JCG) article as an example. The open interest on the JCG June $25 call option is 6510 contracts, according to bloomberg. Stock closed at 24.79. If I’m a mkt maker and I sold clients this option, I would have had to buy stock to hedge myself. Ideally, it’s in my interests for JCG to close as close to $25 as possible, thereby creating what’s called “pin” risk for the owners of the option. Say the stock closes at 24.99 tomorrow. The call options expire worthless and, if you’re a good mkt maker, you would have sold your long position in the stock on the close, leaving you with zero risk and netting the commissions as your own.

This pin risk happens with all assests that have options on them (bonds, idicies, commodities, fx, etc) and it’s usually only on expiration that this happens. Tomorrow is a big expiry (month end, quarter end) so you tend to see some screwy price action on the close (and on the open for index options).

I think as an entrepeneur, the benefits of tapping the public capital markets far outweigh the price action on 12 out of 252 trading days.