2 Concepts: Sound Similar, Totally Different

08/14/2013 8:00 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Option trader Alan Ellman of TheBlueCollarInvestor.com explains the difference between two different concepts: one is used in selling covered calls, while the other is an illegal market activity.

Education is what makes covered call writers in the BCI community an elite group of retail investors. A few weeks ago I produced an Ask Alan video titled “What role does the mark play in our covered call writing decisions” A few members inquired if the mark was related to a term they had heard named marking the close. This article will define the terms, explain the differences, and show some examples.

The Mark
Let’s start with the easier to understand term, the mark: This is the mid-point between the bid-ask spread. If thebid is $3 and the askis $3.40, the mark is $3.20. In our covered call writing strategy, we use the mark as a guideline for playing (negotiating) the bid-ask spread. Let’s take a real-life example: Here is the options chain for PRLB.

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PRLB options chain
Click to Enlarge

For the $65 call options, the bid-ask spread is $0.30 and the mark is @ $4.85. When placing our limit order to sell our covered call options, we slightly favor the market maker and may place a limit order slightly below the mark, say @ $4.80. If executed, this puts $10 per contract in our pockets. Agreed this is not a windfall but it does add up over the years and it’s cash better in our pockets than in those of the gazillionnaire market-makers.

Marking the Close
This is an illegal act by (usually) fund managers of buying a large number of shares of a specific security at the end of a quarter at a much higher price than the current market value. This will drive up the value of the stock and make the fund look more successful in the eyes of its investors. This is also known as portfolio pumping. The Wall Street Journal did a study that found that on the last trading day of a quarter there was a substantial number of stocks that beat the market by >5% and then trailed it by >3% the next trading day. This stat showed up 23% more on the final day of a quarter than any other trading day in a quarter. Here’s a real-life example with IRIX during the last trading day of the 2nd quarter, 2012:

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Marking the Close with IRIX
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IRIX didn’t break through the $4 level until October 2012. The SEC and FINRA are well aware of this practice but it is very difficult to measure and even harder to prove.

Conclusion
The mark and marking the close are two completely different concepts. We use the mark as a guide for retail investors to negotiate a better bid price when selling covered call options. Some fund managers illegally mark the close to make their holdings appear more successful to their investors. That being said, most fund managers are ethical players who abide by the rules.

By Alan Ellman of TheBlueCollarInvestor.com

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