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What is to stop someone from first buying a bunch of OTM puts and then selling short enough stock to make the puts go up high enough to make a profit? Or conversely, buying OTM calls and then buying a bunch of stock?

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    $\begingroup$ How does that someone plans to get rid of the stock position afterwards? Most likely, this will result in a larger loss than the option profit. $\endgroup$ – Sjoerd May 10 '15 at 11:30
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    $\begingroup$ I think it's an interesting question because it introduces volume into the equation, something that you typically don't find in option pricing models. To have no arbitrage, there should be no profit. If buying 100 shares causes the price to rise from x to x+a you have a profit of 100*(a/2) by taking the midpoint. If you bought a call option before doing this you would also have a profit on the call,too. But to sell the 100 shares, the price would fall back to x , resulting in a loss of 100(a/2). Under no arbitrage, the profit from the call should cancel out this loss. $\endgroup$ – Thomas Baert May 10 '15 at 12:02
  • $\begingroup$ Is the idea to exit the short stock position that one built up via puts? That would not work as exercising long puts would put more short stock into the manipulator's account $\endgroup$ – baerrus May 11 '15 at 17:09
  • $\begingroup$ Your strategy is essentially asking whether shorting the stock has enough market impact to cover the put premium. This is interesting from empirical perspective, on the other hand I would expect that these kinds of strategies are already priced in by the market, so the paid option premium prevents the profitability of such kind of strategies. $\endgroup$ – emcor Jun 9 '15 at 9:05
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The quick answer is: There's no such thing as a free lunch, the no-arbitrage principle.

The longer answer:

To push the price down, you must short a massive amount of shares relative to float (tradeable shares). Don't forget that to have a short position, you must actually sell the shares. If you short large volume, then the market price will go down, but so will YOUR selling price.

This means your average selling price relative to normal volume trading is low. Remember that profit on a short position is: sell price - buy price. You must buy back the shares to make a profit. Since the price is artificially low, it is likely to rebound as others (most likely algorithms) will spot the sudden price lowering for no reason and buy the shares at bargain prices. The price will quickly rebound. Even if you were quick on your toes and sold the put options at a profit, you must still buy back the shares at higher prices than you sold at.

This strategy will result in huge losses. If it were to be a profitable strategy, it would not be because the market would spot the mispricing and correct for it. Otherwise, arbitrage would be possible.

Flash Crash

Note selling huge quantities of shares is not illegal in itself. But fake trades and false information to manipulate prices is.

You may be interested in looking up the Flash Crash of 2010. The accused trader made profit by manipulating prices, close to what you were asking. The difference is he put in massive fake trades in order to drive down prices. The trades were "fake" as they were never executed. He would put in massive quantities of sell orders on futures, but above current market prices, giving the allusion people were dumping shares. This drove the price down.

This is a much better strategy than shorting shares as you propose. The only problem is you won't get to enjoy your millions from a jail cell ;)

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  • $\begingroup$ Why are you so certain the strategy would result in "huge losses"? Actually options are very cheap and have a leverage, so you may actually still make a profit because the loss from shortselling stock is outweighed by the leveraged option position. $\endgroup$ – emcor Jun 10 '15 at 12:59
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Is the stock so easy to manipulate? How much does she need to spend to drive the price against her, far enough to pass the strike and make a profit? For a stock that is that thinly traded to be manipulated, is there sufficient liquidity in the options market? What about the hedging positions of the guys that sold options to her?

It is also most probably illegal.

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  • $\begingroup$ Your post is not an answer rather a question and comment. $\endgroup$ – emcor Jun 9 '15 at 9:06

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