Registered User Joined: 7/24/2005 Posts: 10
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How does stock options trading influence price charts?
I'm assuming that simple opening/closing option positions do not register in the stock's chart at all (please correct me if I'm wrong). However, what happens when options are exercised?
As a concrete example, let's say MSFT currently trades at $27, and someone exercises a $20 call option. This means that potentially several hundreds (or thousands) shares are bought at $20. Would this appear as a downwards spike on the stock's chart? Would this add a huge tail to the day's candle? (possibly affecting trading decisions based on Japanese candlestick analysis, patterns, stochastics, etc)
The other two alternatives I see are that either the transaction is not recorded at all (which seems absurd, given the fact that it may involve millions of shares changing hands), or that it is recorded in the current price (but would that be the Ask, or the Bid? and again, this seems too arbitrary...)
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Registered User Joined: 12/19/2004 Posts: 457
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You should check out McMillian's text Options as a strategic investment for info about this.
Whenever someone buys or sells an option, a market maker takes the other side of the transaction.
The market maker is usually trying to make the spread between the bid/ask. He doesn't normally have any interest in directional moves, so he hedges his position in various ways.
In your example, if someone bought a $20 call, then someone had to sell it to him. What likely happened is that a market maker sold him the call (at the ask), and the MM either bought stock (and a put), or a different option, to hedge his risk. He probably offset that position later (at a profit) when someone wanted to sell the MSFT $20 (say as part of a covered call write, or a spread).
The MM sold at the ask, and bought at the bid, so he made a profit, provided MSFT didn't change significantly in that time period.
What happened to that call when it gets exercised?
The option buyer informs his broker he wants to exercise. The broker relays this to the OCC (Options Clearing Corp.) who then find brokers who have customers who shorted that option. Shorts are picked out at random to deliver the stock.
If someone was covered when they wrote the call, then the stock is simply removed from their account, and they get the cash (ie. 20/share). If they are uncovered, they have to buy the stock at market.
How does this affect the charts? If you see heavy call volume, you should also see heavy stock volume, or heavy volume in another series of options. Market makers get suspicious if they see heavy volume in an option, and they will want to protect themselves. So they will either buy another option, or stock, if the options are too expensive.
Ultimately, bullish (or bearish) activity in the options is eventually transfered to the underlying by market makers.
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Registered User Joined: 7/24/2005 Posts: 10
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Thank your for your detailed answer, and I will also check out the book you recommended.
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