Trading Places with Tom Bowley

This Is How Market Makers Steal From Us

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You might think the stock market is really unpredictable and, for the most part, I'd agree with you. But when we get to options expiration week, there is a consistent theme that emerges nearly every month. The market makers are looking to steal you blind. Once per month, on the 3rd Friday of the each month, monthly options expire. Over the years, the tendency is for the stock market to rise during the middle part of most calendar months. Since 1950, the S&P 500's annualized return is as follows for each of the following calendar month periods:

26th through 6th: +20.65%

7th through 10th: -5.50%

11th through 18th: +14.14%

19th through 25th: -8.69%

The 11th through the 18th is very solid. It's important to note that Friday options expiration will occur sometime from the 15th of a calendar month through the 21st of a calendar month. Because the stock market's tendency is to move higher through the middle of the month, there's an interesting phenomenon that occurs as options expiration approaches. Many traders have "in-the-money" call premium on options they've bought. Market makers have financial incentive to reverse those "strong" stocks into options expiration Friday - and into the following week. The reason that the incentive can move into the following week is that options can be exercised. When that occurs, market makers simply move from being a seller of call options to a seller (short) of the underlying stock.

Market makers essentially pay themselves a little bonus when they drive prices lower into options expiration, or the following week and it's at OUR expense. In my Daily Market Report to EarningsBeats.com members today, I estimated the options-related savings on the SPY (at its intraday low) alone to be close to $500 million! This is a short-term market inefficiency that I discuss ALL THE TIME at EarningsBeats.com.

Would you like to see how it works?

Stocks, industry groups, and sectors can be evaluated based on relative strength by simply comparing SCTR scores. Strong stocks or groups (think high SCTR scores) would likely falter into options expiration, while weak stocks (think low SCTR scores) would do much better - potentially reversing downtrends so that market makers can reduce the amount of "in-the-money" puts. Friday was a rough market day and you might think it was like any other day of mild selling. But into options expiration, the leaders get WAXED and the laggards suddenly come to life. Here are a few examples.

Sector Manipulation

Here's the sector leaderboard for Friday (note the SCTR scores):

The two clear sector leaders on Friday have SCTR scores near 20. The three worst sectors also have the three highest SCTR scores among the eleven sectors.

Industry Manipulation

First, let's look at the industry groups within the consumer discretionary sector:

The two groups gaining more than 1% on Friday's session had SCTR scores of 35 and 25. The six groups that lost 2% or more all had SCTR scores above 60.

It was even more blatant if we look at the industry groups within the technology sector:

The three worst SCTR scores among these industry groups miraculously avoided the selling today. But the absolute best SCTR score belonged to renewable energy, which was CLOBBERED!

Stock Manipulation

The best index to discuss for options manipulation is the NASDAQ 100 ($NDX), because many of its component stocks are heavily traded in options. Let's look at the top 15 performers on the NDX on Friday, followed by the 15 worst. Again, focus on those SCTR scores:

The day's NASDAQ 100 losers:

Of the top 15 NASDAQ 100 performers on Friday, only one had a SCTR score above 50. Nearly all of the top 15 worst NASDAQ 100 performers had SCTR scores above 50.

Moral of the Story

As a trader, you MUST understand the idiosyncrasies of the market maker. It's the difference between being incredibly successful or grasping at straws.

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Happy trading!

Tom

Tom Bowley
About the author: is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market. Learn More
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