AFM logoUntil a decade ago, it was common for market makers to accumulate massive open interest in call options before dividend. The boosted open interest in in-the-money calls was usually created against related entities under the same holding.

The idea was to take advantage of retail investors neglecting to early exercise their in-the-money calls before dividend. Having a short call non-assigned means pocketing a piece of free dividend. The non-assignments are divided pro rata.

Massive size in dividend calls

This kind of “arbitrage trading” was massive. For instance, in August 2005 in ABN Amro options 45 million contracts changed hands the day before  ex-dividend. Juggling with millions of contracts wasn’t without risk. In August 2004 (yes, 12 years ago – we’re getting old) Saen Options created millions of open interest in call options ING before ex-dividend. Extra Clearing messed up their exercises. Rival market makers (mainly IMC, Optiver and Curvalue) divided €6 million.

It was the end for Extra Clearing, who had just suffered from a blow from Goed Gedaan Options (Allard Jakobs), who lost his shirt in the “Arnhemsche – Akzo” spread. The irony is Extra Clearing was owned by ING.

Paranoid on ex-dividend

Ever since, market makers have been paranoid on exercising call options (check, double check). In 2006 Euronext introduced measures to curb this activity, introducing fines. Selling in-the-money calls on-screen was fined, when exceeding a threshold of 10 contracts. That’s a strange deal. Market makers are obliged to quote these calls, but aren’t allowed to sell.

Wash trading

The Dutch authority on financial markets (AFM) has shared their vision on dividend calls. And how they see crossing dividend calls against related entities. According to the AFM, crossing options against yourself (or a related entity) means nothing changes for your risk and position. And that’s wash trading. Illegal. A definition according to the ESMA:

Wash trades. This is the practice of entering into arrangements for the sale or purchase of a financial instrument where there is no change in beneficial interests or market risk or where the transfer of beneficial interest or market risk is only between parties who are acting in concert or collusion.

You could argue whether the dividend call option trading creates no market risk. There are situations where having a significant long and short position in the same option creates a big risk.

Euronext cancels all rules on dividend call trading

Euronext never felt at ease with their regulation to charge extra fees for selling in-the-money calls before dividend. It conflicts with other regulations. Market makers have the duty to quote the same calls.

In other words, Euronext is more than happy to throw these regulations in the garden of the AFM. All rules and regulations from Euronext on the matter are cancelled with immediate effect. Market makers fear the impact of the AFM, and will certainly stay on the safe side.

Euronext : Cancellation of rules in relation to call option dividend trading (pdf)

Other news on Optiver and KCG

  • There was a rumor in the comments as well as in the Australian press Optiver would move it’s Asia-Pacific headquarter from Sydney to Hong Kong. The rumor is absolutely nonsense.
  • KCG is leaving the wholesale market making in options to retail brokerages (Bloomberg). This payment-for-order-flow (PFOF) in retail options is a business IMC Financial Markets just moved in together with broker Convergex.
Jack
Jack