Photo Credit: theilr || Cute dog, huh?

There are a pair of articles regarding the efforts of a few people posting at Reddit to make money in stocks as part of a perpetual motion machine. The articles are here: Businessweek, Matt Levine.

The idea is for a bunch of people to buy calls in the morning, which forces market makers to hedge by buying the underlying stock, which pushes the price up, giving automatic gains. Now, real hedgers hedge options using options, but the net effect should be the same regardless.

What the speculators mentioned in these articles don’t get is that they are violating rule XXXII:

Dynamic hedging only has the potential of working on deep markets.

Arbitrage pricing can reveal proper prices in smaller less liquid markets if there are larger, more liquid markets to compare against.? The process cannot work in reverse, except by accident.

The Rules, Part XXXII

The quick summary of this is that the tail can’t wag the dog. The amount of money in the options market is far smaller than the money in the stock market. As such, if speculators try to overwhelm the market for a given stock with call purchases, real money sellers will happily oblige them and provide them with stock. They will not win on average.

There are no simple magical money machines in the market. Those that think they have one have deceived themselves.