Examkin

Question

Difficulty: MediumProhibited Market Manipulation and Fraudulent Practices

An institutional investor holds a significant short call option position on a stock expiring at the end of the week. To prevent the options from moving into the money and being exercised, the investor submits large sell orders in the underlying security near the close of trading to artificially depress its market price. Which of the following prohibited market practices has taken place?

  1. CappingAnswer
  2. B
    Wash trading
  3. C
    Spoofing
  4. D
    Free-riding

Answer

Capping is the prohibited market practice of selling an underlying security to artificially lower its market price, preventing short call options from becoming in-the-money and being exercised.
Capping is an illegal market manipulation tactic designed to keep the price of a security below the strike price of a call option. Investors with short call positions engage in capping to prevent option buyers from exercising the contracts.

Step-by-Step Solution

1
Analyze the trader's activity and underlying position
The trader is short call options and actively sells the underlying equity near expiration.
Understanding the derivative position clarifies why the trader is motivated to manipulate the equity's price downward.
2
Match the behavior to SEC/FINRA regulatory definitions
Placing sell orders to keep a stock price down and avoid call exercise is defined as capping.
Distinguishing specific manipulative tactics ensures precise categorization of prohibited activities.

Key Concept

Capping
Rate this question

Topics

Prohibited Market Manipulation and Fraudulent Practices