I’ve been trading a specific option strategy for a while now, and Tim Bourquin asked if I would share it with MoneyShow.com readers.
Every month, there is one stock that market makers manipulate on options expiration day—here’s why and how. 75% of the time, they will pin the stock at a $10 increment, and you can reliably predict which price the stock is going to end at by the time the market closes. Knowing the end price of a stock on expiration day is incredibly powerful knowledge and a way to produce amazing returns in a highly predictable monthly trade. It's like betting on a sports game except you already know what the final score is going to be, so all you have to do is pick which team wins—during the game—the bulls or the bears.
The stock that the market makers manipulate is Google (GOOG). I first noticed this happen back in October of 2006 when Google released earnings the day before options expiration, like they always do. They had a blowout earnings report and the stock gapped up $30. Curiously, the price action the day after earnings was flatlined, and the stock never moved more than $5 from a price I can no longer remember. Curious, I read the Yahoo forums a little and all the traders were saying it was the market maker’s way of keeping the price down so that Google would explode the following Monday. Sure enough, that is exactly what happened. I was in and out of Google the following week for a nice return and then Google was out of sight and mind.
Fast forward to September 2009. I sold some Google put credit spreads and heading into options expiration week, I remembered what happened back in October 2006. So curiously, I again watched the price of Google on options expiration day and sure enough, same thing! Google was put within $2 of a $10 increment again. It was actually at about $491.00 before it was bought up to $491.46 during the last one or two minutes of trading. I made 33% on a one-day options trade and I was intrigued. I went back over the ending price of Google for the past two years on options expiration day to see if this was a coincidence or a reoccurring pattern. What I found out made it difficult to sleep at night for the next week!
I had discovered that a particular trade was happening on a regular basis in a highly predictable fashion. Now that I discovered it, I needed to know why it was happening. Market makers sell tons of Google options during the course of their trading. So when Google options are going to expire, they will do their best to manipulate the price of the stock and pin it at a $10 increment—$510, $520, $530, for example. Why? So that all the calls and puts that they sold at that level will expire worthless, it is their maximum profit range as an option seller and max pain for option buyers. If the stock ends at $525, the market makers will get some of their options exercised.
This is the price history of Google for the last two years on options expiration day:
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The market was closed on expirations day on March 21, 2008, and I don't know which day was actual expirations, so I’ve omitted this month.
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Of the last 24 option expiration months, 18 out of 24 were within +- $2.50 of a $10 increment. Of the six that were not within $2.50 of a $10 increment, the days were fairly volatile with a difference of more than $10 between the high and the low for four of the six.
The strategy that I am going to use for this trade is buying in-the-money calls or puts after the price action of the day tells me which $10 increment Google is going to end at. I want to pay $600 for the option and sell it for $900 (these numbers are of course only price targets and not set in stone). It is important to not pay much less than $600 for the option. Why? If you’re paying less than $600, that means you don't know which way the stock is going. For example, if Google is at $496, it is better to pay $600 for the 490 calls then it is to pay $400 for the 500 puts, and vice versa if Google is at $494. If the stock is going to gravitate to $500 from the market maker's price manipulation, you want the 490 calls, which means paying $600 for your options is better than paying $400. Make sense? It is also important to not pay too much for your option. If you buy them for $800, you don't leave that much room for profit if the options cap out around $900-$1000 and the exposure to downside is much greater with more limited upside.
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Lets take a look at the most recent price action for Google on October 16, 2009. The attached chart shows the price action for the day. The stock opens at 547.33 and immediately drops down before bouncing back up. Over the next couple of hours, it appears its headed to $550. Google breaks $550 and reaches the high of $554.75 before heading back down. When the stock starts to head back toward $550, that should be your signal that the market makers objective price is $550 and not $560 and a sign to enter the trade buying 560 puts. You could have also made money buying 540 calls earlier in the day, but I usually like to wait until later in the day to decide which price Google will end at. Aggressive traders could have entered the calls and then set a trailing stop to make more money when Google went past $550. For October options, I bought 560 puts for $600 and sold them for $900 the same day. The beauty of this is that I didn't feel like I was making a gamble or speculating. I knew what the market makers wanted to do and all I did was wait for it to happen and execute.
This is an amazingly simple, powerful, and repeatable trading strategy with a high probability of success. I would have been excited if this was a trade that happened every quarter, but the fact that it happens nearly every month is truly amazing.
By Will Reed, active trader
