3
$\begingroup$

If I have a large order to fill, shouldn't I always buy a derivative in the same direction to profit from the market impact?

E.g. I sell 1 million shares and so I buy a put, which will hence almost surely increase in value (due to large market impact).

I understand that I lose value from selling shares as the price goes down, but my point is more about always adding the put (assuming I want to sell the shares anyways)? It would be a kind of self-frontrunning strategy.

|improve this question
$\endgroup$
  • 2
    $\begingroup$ What makes you think you can get a derivative position on with zero market impact? If your equity position will have market impact it is almost certain that any derivative position you want to establish will also suffer impact. $\endgroup$ – Louis Marascio Aug 4 '15 at 13:55
  • $\begingroup$ I think I get your point now. Imaging that you move the market, you will win money with a call option, not a put. A put option is worth less the more the market rises. In the other hand, you should buy faster than you sell the shares $\endgroup$ – arodrisa Aug 4 '15 at 14:43
1
$\begingroup$

Just take a look at the bid ask spreads plus transaction costs. It's nonsense what you are saying because on one side you implicitly assume enough liquidity so you market maker executes the Delta of your position. On the other hand you assume the market is liquid so you can move the market when you sell your position.

|improve this answer
$\endgroup$
  • $\begingroup$ I was expecting that the option to be bought has already been hedged in advance? $\endgroup$ – emcor Aug 4 '15 at 21:36
  • 1
    $\begingroup$ Why one would do that? The price of the option in an arbitrage free market equals the replication cost i.e the delta hedge strategy to simplify. So it doesn't make much sense to first hedge and then sell the option later. Either the market maker gives you a price such that he has enough room ti accommodate market impact or you limit the price which he can execute his hedge and only after he's fully hedged he confirms the trade. Either way even if you trade a huge notional when you ask for an exit trade the bid ask spread would kill the profit $\endgroup$ – Tulio Carnelossi Aug 4 '15 at 21:43

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.