I’ve been following GEOY for quite a few months now, and every month on or near options expiration, the stock takes a beating and closes near an option strike price. Numerous academic studies have shown that on options expiration Friday, stock prices tend to close around option strike prices. This does not happen with stocks without options, only with optionable stocks. What is happening is that options traders systematically look for stocks which command a high option premium yet has a low trading volume. The traders proceed to sell a large number of options and collect the option premium (in GEOY’s case, I’m referring to call options), and then starting about a week before options expiration, they slowly short the stock downwards to close at or near the strike price. The call options expire worthless, and the traders then cover their shorts while driving up the share price tantalizingly close to the next option strike price, thus luring the next batch of option buyers in for the kill.
If you look at the short interest of GEOY, you’ll see that shares short declined dramatically after the successful launch GeoEye-1 last year, with short covering probably responsible for GEOY’s spike above $25. Since then, trading volume in GEOY has declined significantly, yet at the same time, there has been considerable bullish attention on the stock among retail investors, and many of these retail investors apparently has opted to buy call options rather than the shares, resulting in a very rich options premium. In the midst of this positive attention, shares short has actually been rising modestly but steadily, probably because the option traders have been unable to completely cover and sterilize their short shares.
The game of retail investors versus institutional traders is a particularly lopsided one. Not only do retail investors have less capital then traders at investment banks, even when they refuse to sell their shares at unreasonable prices, traders can always borrow the shares from the retail investors’ very brokers to short. In fact, with ineffectual SEC surveillance, I wouldn’t be surprised if there is some naked short selling going on. In other words, the traders can conjure up and infinite supply of phantom shares and the share price will be exactly where they want it, regardless of the opinions of the retail investors.
What can the retail investor do about it? The one thing you can do is to stop buying call options! Buy the shares instead. If you really want the leverage, consider using margin. As I am typing this, the Mar $20 call options is selling for about $1, representing a 5% return in a single month. The margin interest you incur in a single month will be dramatically less than this.
Will we always be at the mercy of the traders? There are several ways that this will end. Firstly, management does hold an appreciable amount of stock, and better communication on their part about the company’s earning prospects may attract another institutional buyer with enough firepower to face down the manipulators. Secondly, there are signs that the traders are gradually accumulating a net short position, because they are unable to cover their shorts at cheap prices. At some point, the risk department in their bank will sit up and take notice, or more likely, some other opportunistic trader will notice and proceed to set up a short squeeze.
