Ask The Expert
Dear Mr. Brinkman,
I've been hearing a lot about options, and I'd like to know more about them (I'm fairly new to trading). Why do people buy options? For example, how does buying an option compare to buying a stock?
Thank You,
Anonymous Trader
Tips of the Trade
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New Short Sale Rule
Prior to July 6 there was a rule that limited when a short sale of stock could be executed, otherwise known as the Uptick Rule (Rule 10a-1 under the Securities Exchange Act of 1934). This past July, the SEC eliminated the Uptick Rule. Because you can now short a stock with less limitation, many people are wondering if this has caused an increase in volatility in the stock market.
There have been many articles and blogs written about this very subject. Since the rule elimination, the U.S. markets have experienced the highest volatility levels since 2003�, and the NYSE has experienced its highest historical volume. Some believe that there is more than just a coincidence between the elimination of the Uptick Rule and the recent market swings. It is important to note many other changes in the markets have occurred recently (such as the increased automation of some markets and Reg. NMS), so it is difficult to quantify exactly how much impact the elimination of the Uptick Rule had on the markets. However, there are still some interesting points to consider.
First, the NYSE Tick Index ($USN/TICK) indicates the number of stocks on the NYSE that are trading on an uptick, minus those that are trading on a downtick. Since the elimination of the Uptick Rule, this index has been much lower than normal despite strong positive days in the markets. Some theorize that hedge funds and large institutions, previous to the rule elimination, created upticks in order to execute short sales.
The second fact to consider is that the short interest has been increasing and that this is the most heavily shorted market in history�. The ability to short was being well practiced before the Uptick Rule was eliminated. Considering that the short interest on the NYSE reached all time highs in each of the four months prior to the Uptick Rule elimination, and since then, the short interest has decreased every month. Remember the more outstanding short shares, the greater the likelihood of violent swings to the upside in short-covering rallies.
Finally, a study by Ohio State University professors conducted after a pilot test of the elimination of the Uptick Rule showed the Uptick Rule elimination did not result in an increase in daily volatility. However, the pilot program was before other changes in the market - such as the increased automation of the markets and Reg NMS. Also, the study did not take into account the possibility of using short selling to manipulate small cap, micro cap and other thinly traded issues.
So, in conclusion, did the elimination of the Uptick Rule affect volatility? I think it did. But I believe the volatility in the structured credit market initiated by the subprime collapse is the real culprit. Remember that short-sellers are still required to go through the cumbersome process of borrowing shares before they short. This is not a blank check to short shares whenever anyone pleases.
Brian Bachelier
Market Structure Analyst at Scottrade
�"highest volatility since 2003"
�"most heavily shorted market in history"
Subscribe to In The Know RSS| San Diego | 7/30/11 |
| New York | 8/6/11 |
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