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Question

Difficulty: HardProhibited Market Manipulation and Fraudulent Practices

A compliance officer at a member firm reviews activity logs and discovers that a proprietary trader holding a short call option position repeatedly enters non-bona fide sell orders for the underlying stock just prior to market close. The trader's sole purpose is to depress the stock's closing price below the option's exercise price, ensuring the call option expires unexercised. Which of the following prohibited market manipulation tactics has the trader committed?

  1. CappingAnswer
  2. B
    Wash trading
  3. C
    Bona fide principal market making
  4. D
    SRO-sanctioned proprietary hedging

Answer

The prohibited practice is capping, which involves entering sell orders for the underlying stock to prevent its price from rising above the strike price of a short call option.
The correct answer describes capping, which occurs when a trader with a short call option position attempts to suppress or cap the price of the underlying security by entering sell orders, thereby preventing the option from expiring in-the-money.

Step-by-Step Solution

1
Analyze the trader's motivation and transaction pattern in the scenario.
The trader holds short call options and enters non-bona fide sell orders to keep the underlying stock price below the exercise price.
Identifying the specific derivative position and the market pressure exerted is key to distinguishing market manipulation types.
2
Match the observed behavior with FINRA and SEC prohibited activity definitions.
Entering sell orders to cap or suppress a stock's price from rising above an option strike price is defined as 'capping'.
Capping directly attempts to manipulate market prices to prevent call options from expiring in-the-money.

Key Concept

Market Manipulation Tactics (Capping vs. Other Prohibited Practices)
Estimated Time:1m 30s
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Topics

Prohibited Market Manipulation and Fraudulent Practices