Allegations of market abuse abounded last Friday when the FTSE100 options and futures expiration price spiked minutes before the contracts were due to expire, landing substantial volumes of previously cheap out-of-the-money call options heavily in the money. The apparent sensitivity of the expiry auction to a large stock buyer, who jumped in at the eleventh hour, left dealers questioning the efficiency of this system for determining expiry prices.
Traders said 1000 call option contracts with strikes at 5075 and another 1000 contracts with strikes at 5125 were bought on Thursday. Both trades ended in the money when the FTSE100 rocketed to 5137.8 at expiry on Friday, having traded in a range of 5060-5090 for the previous 15 minutes. The profitability of the trade could not be determined by press time.
The expiry price auction is run by the London Stock Exchange at 10am each third Friday of the month for options, and each quarter for futures. Although it was impossible to tell if the stock buyer was connected to Thursday's call option trades, traders at several houses agreed it looked suspicious. "If this is proved to be market abuse, it's a very serious matter," noted one official, who said it could end up in a fine for the counterparties by the Financial Services Authority.
"It's a dangerous game, but it was played by the book," noted one FTSE derivatives trader, who said he would talk to his cash trading colleagues before deciding whether to lodge a complaint with FTSE or the LSE. But he added buying FTSE call options at 5125 was not unusual because on Thursday they were cheap and out of the money. Similarly the 5075 strike options were cheap because they were not seen as likely to end heavily in the money, he explained.
The auction system used to calculate the FTSE Exchange Delivery Settlement Price was rejigged in November, and several traders said it has not been long tried and tested and this situation suggests it is not foolproof. June's expiry is always a big one because it covers options--which expire monthly--and futures with quarterly expiries. Catherine Mattison, spokeswoman for the LSE, confirmed the expiry price. Mattison declined comment on whether the LSE would hold an enquiry into the event, but said the exchange closely monitors all expiries.
