| Last year, Jane Street Group sued Millennium Management for allegedly stealing its secret trade ideas. Jane Street had employed a couple of traders who discovered a trading strategy in the [redacted] market. Jane Street did some initial testing and found results that were "counterintuitive, unexpected, and initially met with significant skepticism and incredulity internally at Jane Street": It made so much money that everyone thought it was a mistake. Jane Street started running the strategy in the [redacted] market and made a lot of money. Eventually the traders left for Millennium, and then Millennium allegedly started running the same strategy, eating into Jane Street's incredible profits. In its lawsuit, Jane Street did not describe the strategy, or even name the [redacted] market in which it was operating, because "even identifying the country involved would lead to others 'picking apart' the details." But in a court hearing, Millennium's lawyers repeatedly said that the strategy involved options trades in India, "at multiple points apologizing to the judge for doing so." Oops! Oh well. We talked about this a couple of times, and I found it very amusing. (They settled in December.) Do you know who did not find it amusing? The Securities and Exchange Board of India, the Indian securities regulator. From SEBI's perspective, the story here is: - Jane Street found a counterintuitive way to extract unbelievable amounts of money from the Indian options market.
- It didn't want anyone to know about it, because if that got out someone would blow up Jane Street's spot.
If you are a national securities regulator and you learn that a big international firm is making unbelievable amounts of money in your markets and keeping it secret, that doesn't sound like good news for you. SEBI was sort of obligated to blow up Jane Street's spot, and last Thursday it did: India has temporarily barred Jane Street Group LLC from accessing the local securities market for alleged index manipulation, dealing a severe hit to the US firm that made $4.3 billion in trading gains there in more than two years. The Securities and Exchange Board of India said it would seize 48.4 billion rupees ($570 million) from Jane Street, which it claimed is the total amount of "unlawful gains" made by the firm, according to a 105-page interim order by Ananth Narayan, a board member at the regulator, on its website. Jane Street said it disputes the findings. Here is the order, which says that SEBI started looking into Jane Street after reading about the Millennium lawsuit in the papers. Of course it did. I can tell you at least one counterintuitive thing about the Indian options market, which is that it is gigantic. "It accounts for around 80% of equity options contracts traded worldwide by daily turnover," and it is by some measures much bigger than the Indian stock market. The SEBI order notes that, "on weekly index options expiry day, the comparable cash equivalent traded volumes in index options markets is several times the combined cash equivalent volumes traded in the associated futures and cash markets." The order focuses on Jane Street's trading on one day, Friday, Jan. 17, 2024, an expiration date for the then-popular weekly cash-settled options on the Nifty Bank index. [1] Roughly 103 trillion rupees' worth of those options traded that day, [2] 353 times the trading volume of the 12 actual bank stocks that make up the index. Two points here: - That's weird!
- Just from that paragraph you should know exactly what Jane Street is accused of doing.
So, first: It's weird to have an options market that is much bigger than the underlying stock market. The explanation here seems to be largely that Indian retail investors enjoy a gamble, and the best way to gamble on stocks is with options. Here is a March 2024 Wall Street Journal story about the Indian retail options boom, noting that "individual investors in aggregate are losing large sums, while many brokerages and the stock exchanges are raking in cash." And Bloomberg News notes today that "demand for so-called equity options in particular has exploded as large numbers of relatively inexperienced retail investors came in search of quick returns." But there is also a structural story: Compared to other big markets, it is harder to get leverage on cash stock positions or futures in India, or to sell stocks short. [3] Lots of leveraged and long/short trading strategies are harder to do in India, but options — which offer a lot of leverage — are a decent substitute. This suggests two things. First, some trading strategies that would be implemented using stocks in the US could be implemented using options in India. Second, some trading strategies that have to be implemented using stocks — like arbitraging options versus the underlying stocks — are harder to do in India, so some arbitrages won't close and some spreads will be wider. My second point was: Just from the fact that on some days the Indian options market is 353 times bigger than the Indian stock market, it is easy to see how you could get in trouble trading Indian options. Indian options trade much more liquidly than Indian stocks, but Indian options trade and settle based on the prices of Indian stocks. If you can move the stock prices, that mechanically moves the option prices. But the options are easier to trade (they are liquid), while the stock prices are easier to move (they are illiquid). So the Nifty Bank index options that the SEBI order discusses are based on an index of 12 bank stocks. On the day SEBI discusses, Friday, Jan. 17, 2024, the index opened at 46,573.95 (down 3.2% from the previous day's close of 48,125.10), traded as low as 45,789.60 and as high as 47,212.75 during the day, and closed at 46,064.45. There were call options on the index, bets that it would close above a certain price: For instance, a call option with a strike price of 47,000 would pay off zero if the index closed below 47,000, or 1 rupee per point that the index closed above 47,000. (The options are cash settled: You don't get delivery of any stock; you just get cash based on the closing price.) And there were put options, bets that it would close below a certain price: A put option with a strike price of 47,000 would pay off zero if the index closed above 47,000, or 1 rupee per point that it closed below 47,000. At some points during the day the call option looked like it would pay off — the index traded as high as 47,212.75, which would make the call option worth 212.75 — but ultimately the index closed at 46,064.45, so the call option expired worthless and the put option paid out 935.55. But the actual underlying stocks trade much less than the options do. So, schematically, you can buy 100 million rupees' worth of call options, betting that the stock will go up, without moving prices too much. And then you can buy 10 million rupees' worth of the 12 underlying bank stocks, but because those stocks are pretty illiquid, your buying will move prices up. This will cost you money — you'll overpay for the stocks — but it will make you more money on the options: The option prices will go up mechanically to reflect the higher stock prices, and then you can sell your options at a profit (again without moving prices too much). SEBI says: On weekly index option expiry day, many more entities and individuals trade in index options than do entities and individuals in the associated cash and futures markets. In other words, given the interrelationship between prices of derivative instruments and the prices of their underlying stocks or indices, many that trade in index options look for signals in the underlying index (determined by the smaller volumes and less number of participants in the underlying cash and futures markets), without themselves participating in these markets. … Given the above, on weekly index option expiry day, by aggressively influencing the underlying cash and futures market with significant volumes (relative to those markets), a group of entities acting in concert with adequate funds and capital at their disposal, can influence and manipulate the index levels. This in turn can allow them to put on significantly larger and profitable positions in the highly liquid index options market by misleading and enticing large number of smaller individual traders. It could also be used to engineer the closing of the market on expiry day in a manner that benefits enormous index option positions that they may be running to expiry. And that's what Jane Street allegedly did: JS Group first aggressively bought significant quantities of BANKNIFTY underlying constituent stocks and futures, temporarily pushing up or lending considerable support to the BANKNIFTY index. … JS Group ... actively traded BANKNIFTY puts and BANKNIFTY calls … [and] effectively took on active opposite side positions in BANKNIFTY index that were significantly higher in magnitude than the quantum of their intervention in the underlying cash and futures markets. This is a pretty intuitive story, but there is a problem with it. Again, SEBI focuses on a single day, Friday, Jan. 17, 2024. On that morning (from 9:15 to 11:47 a.m.), "Jane Street Group aggressively accumulated significant long positions of INR 4,370.03 crores [INR 43.7 billion, about USD 512 million today] in BANKNIFTY constituents across both the cash and stock futures markets," and this trading "coincided with JS Group simultaneously effectively selling BANKNIFTY via the index options segment." In fact, Jane Street sold much more stock via options than it bought in cash: Its "net increase of cash-equivalent INR 32,114.96 crores [INR 321 billion] in short positions in BANKNIFTY via index options, in absolute terms, was 7.3 times the INR 4,370.03 crores [INR 43.7 billion] long position built by the group aggressively in the component cash/ futures markets." So it was selling about 7.3 times as much index exposure (in the options market) as it was buying (in the cash and futures market). SEBI focuses in particular on the first 8 minutes of the trading day, "the 8-minute patch from 09:15:00 to 09:22:59 on January 17, 2024," when Jane Street bought a lot of the top six banks in the index while also selling a lot of call options and buying a lot of put options: Such activity, particularly in the opening minutes of the trading session, appears to have had a meaningful impact on the index level. The BANKNIFTY index moved significantly from 46,573.93 to 47,176.97 during this patch, a rise of over 600 points.
The intuitive story here is: By buying in the (illiquid) cash market, Jane Street was pushing up the price of the index, which pushed up the prices of index options, which allowed it to sell much more in the (liquid) options market and make a huge but manipulative profit. The problem with this story is that the options went down. Page 26 of the SEBI order lays out the prices of various Nifty Bank index options during the eight-minute window that SEBI focuses on. Consider two options from the table: - The 47,000 put. This is an option that would pay off if the index closed that day below 47,000. At 9:15 a.m., this was trading at 144.9.
- The 47,000 call. This is an option that would pay off if the index closed above 47,000. At 9:15 a.m., this was trading at 479.9.
From the prices of these options, you can back out an implied price for the underlying index. Buying the call and selling the put is the equivalent of buying the underlying index [4] : You pay 335 for the combination (479.9 - 144.9), and then you get all the upside above 47,000 (from the call) and all the downside below 47,000 (from the put). Because you paid 335 of premium, this is the equivalent of buying the index at 47,335. So the options market implied an index level of 47,335 at 9:15 a.m. [5] Notice, though, that the actual index "moved significantly from 46,573.93 to 47,176.97 during this patch." It started at 46,573.93, but the options started at 47,335. The options implied a price for the Nifty Bank index that was 1.6% higher than the actual price of the index: Retail investors were paying more for stock exposure via options than institutions were paying to buy the actual underlying stocks. (Why? The best explanation I've heard is that the index dropped a lot overnight, opening 3.2% below its previous close, and retail investors love to buy the dip — and in India they do that with options. So there was a ton of retail demand for Nifty Bank index exposure via options, which pushed the options prices higher than the underlying index.) By 9:22 a.m., the premium had come down. At that time, according to SEBI, options implied a price for the index of about 47,187, [6] versus 47,176.97 for the actual index, a premium of about 0.02%. And this was below the options-implied index price at 9:15 a.m. As Jane Street was buying the underlying stocks, "temporarily pushing up or lending considerable support to the BANKNIFTY index," the prices of options on that index were going down. This is a very different story from the one SEBI tells. This does not look like manipulation; it looks like arbitrage. This is: Jane Street came in one Friday morning and noticed that Indian retail traders were buying options on the Nifty Bank index at much higher prices than where the index was actually trading. So Jane Street got to work doing what it does: It sold options to retail traders who wanted them, and bought the underlying stocks to hedge, until the arbitrage closed. (More strictly, it net sold call options and net bought put options, giving retail traders long exposure to the index. [7] ) At the beginning of SEBI's window, the options were trading at a pretty wide 1.6% premium to the underlying index; at the end, they were trading at basically the "correct" levels. Over the weekend, Jane Street sent an email to its employees disputing SEBI's characterization of its trading and explaining those eight minutes: Those eight minutes illustrate basic index arbitrage trading, which many of you will know as a core and commonplace mechanism of financial markets that keeps the prices of related instruments in line. One can easily observe that there was a large divergence between the price of the BANKNIFTY index (NSEBANK Index on Bloomberg) reflected in options markets and the price implied by the stock levels. Jane Street (presumably alongside other market participants) traded in a direction consistent with closing that gap and bringing the two markets more in line with one another.
There is a graph: The red line is the actual index price (based on the underlying stocks); the blue line is the index price implied by the options. (The times are 2.5 hours ahead of Indian time, so this chart starts at 9:15 a.m.) The options opened at prices that were much higher than the stocks, so Jane Street naturally sold the options and bought the stocks. In a classic index arbitrage, Jane Street would have bought about as much stock (in actual stock or futures) as it sold (in options), capturing a risk-free profit as the prices converged. That's not what happened here: Jane Street sold much more (in options) than it bought (in stock). I don't know why, though I assume the answer is some combination of "Jane Street had a fundamental view that the options-implied price was too high" [8] and "Indian stocks are much less liquid than options, so it couldn't fully hedge." But that chart does not look especially like manipulation. If two identical assets — here, the cash index and the options-derived index — trade at different prices, you buy the cheap one and sell the expensive one, and Jane Street did. [9] SEBI spends a lot of time on the first eight minutes of trading that day, but more broadly the pattern is that Jane Street bought stock and sold options in the morning, and then sold back its stock in the afternoon. Why did it sell back the stock in the afternoon? SEBI describes this as "extended marking the close." 'Extended marking the close' refers to a manipulative trading practice where an entity aggressively places large buy or sell orders in the final moments of a trading session, with the specific intent of influencing the closing price of a security or index to its advantage. This practice is particularly concerning on derivative expiry days, as the closing price directly affects the settlement value of index-based contracts, thereby impacting payoffs for all market participants. Typically, extended marking the close involves aggressive and large buying (or selling) of securities just before market close to push the price up (or down), to ensure the reference stock or the index sets at a level more favourable for even larger derivative positions that are being settled on that day.
That is: Jane Street got very net short in the morning, by buying some stock but selling much more stock via options. Its options expired at the close, and the lower the closing price was, the more money it would make on its short positions. So it dumped its stock aggressively into the close to drive down the closing prices. But these trades were what you might call "zero-day" options: The Nifty Bank index options expired weekly on Friday, and SEBI is looking at the trading patterns on those expiry days. Retail customers bought a ton of options Friday morning, knowing they would expire Friday afternoon. Jane Street, in effect, sold them the options on Friday morning (when they were overpriced), and hedged by buying the underlying stock. But the options expired (and cash settled) on Friday afternoon: In effect, Jane Street had to buy them back on Friday afternoon (at whatever the closing price was). If the hedge for selling the options is buying the stock, the hedge for buying back the options is selling back the stock. [10] But that's also the way to mark the close: If you were legitimately hedging expiring options positions, or illegitimately manipulating the closing prices to profit from your expiring options positions, either way your behavior would be roughly the same (you'd sell stock toward the end of the day). There would be some differences, though. Traditionally the way to "mark the close" is to trade at the close: If you buy aggressively in the last half-hour, that has more of an impact on pushing up the index than if you trade over a longer period. "Extended marking the close" is less effective, as manipulation, than quick marking the close. SEBI criticizes Jane Street for selling stock "aggressively" over the last hour of trading, but it also notes that "the Volume Weighted Average Price in the last 30 minutes of trading (between 15:00 and 15:30) is used to compute settlement prices" for the options. If you were trying to mark the close, you might sell all your stock in the last half-hour (when trades count toward the closing price), not the last full hour. I suppose the main point here is that, in many cases, "legitimately doing an arbitrage trade" and "trading in one market to manipulate prices in another market" look pretty similar. Either way, you are trading the opposite way, buying stock in the stock market and selling it in the options market or vice versa. The difference can be subtle, and I often joke that the difference between legitimate trading and manipulation is whether you send your colleagues an email saying "lol I sure manipulated that market." Still, there is a philosophical difference. If Jane Street was doing a legitimate arbitrage trade, that would have the tendency to make markets more efficient, to reduce the prices that Indian retail investors were paying for their options. If it was doing market manipulation, that would have the tendency to make markets less efficient, to make options more expensive for the Indian retail investors. I don't know what happened here, but judging by SEBI's own chosen example, it looks like Jane Street was making markets more efficient and benefiting, rather than harming, retail traders. Instead of paying a 1.6% premium to buy stocks in the options market, they could pay a zero-ish premium; Jane Street pushed the options prices down and closed the arbitrage. But it also made a ton of money? You can see how all of this might be "counterintuitive, unexpected, and initially met with significant skepticism and incredulity." The story here is something like "Indian options were so popular, and so hard to arbitrage, that Jane Street could make billions of dollars just moving them to their correct prices." That story should be annoying to SEBI too, even if it's not Jane Street's fault. "Imagine," I wrote last month, "if mergers and acquisitions were illegal." It is a useful little thought experiment. In a world where M&A was illegal, big companies would still want to buy smaller companies, but they couldn't. They would need to construct indirect workarounds. I discussed a few: If a big company liked a small company's employees, it could hire them all; that's not a merger. If it liked a small company's product, it could enter into some sort of commercial arrangement, an exclusive licensing deal or sales partnership or supplier relationship or whatever, and end up selling the small company's products to its own customers. All sorts of commercial arrangements are possible that stop short of buying the company, which, in this hypothetical, is illegal.
We were talking mostly about recent trends in tech companies, where (1) there has been a lot of regulatory scrutiny of acquisitions and (2) big tech companies have used workarounds like these (acquihires, exclusive commercial arrangements) to get around that scrutiny. But there are other applications. At Business Insider this weekend, Jacob Shamsian wrote about law firm M&A. In the US, M&A for law firms is not exactly illegal (law firms merge all the time), but it is severely restricted: For the most part, only other law firms can buy law firms, because "nearly every state has adopted a professional ethics rule from the American Bar Association forbidding lawyers from working for nonlawyer-owned firms." So US law firms mostly can't go public, or be acquired by public companies, or be acquired by private equity funds. But … could a private equity fund enter into some sort of commercial arrangement, an exclusive sales partnership where it sells the law firm's services to clients and takes a cut of the revenue? Sure I guess. Shamsian: The loophole, known as a "managed services organization" — or MSO — allows non-lawyers to effectively own part of law firms through a second corporate entity. … As a workaround, the law firms can set themselves up as two corporate entities, [lawyer Lucian] Pera said. One is the law firm itself, composed exclusively of lawyers and owned only by lawyers. The second is the service organization, which can be owned by anyone and acts as a vendor for the law firm. It is essentially the back office, taking care of all non-lawyer tasks, including marketing, accounting, human resources, real estate leases, and employing paralegals. The two corporate entities enter into a long-term contract. Under this MSO arrangement, non-lawyers can invest in the service corporation, though not the law firm itself. Presto! You have an ethically independent group of lawyers who are exclusively working with a company that can sell shares, Pera says. According to Pera, no state bars have issued ethics opinions that expressly bless the MSO model, but no court or regulator has found a problem with it, either. Good enough! If the MSO is the exclusive vendor of the law firm's legal services, then owning the MSO is economically pretty close to owning the law firm. I feel like at this point no one's long-term thesis on Tesla Inc. is "from here on out, Elon Musk will spend all his time and energy making Tesla the very best cars-and-robots company it can be." There was probably a time when Musk was monomaniacally focused on Tesla, but that was a long time ago. Or, rather, there was probably a 17-minute window last week when Musk was monomaniacally focused on Tesla, but the last two-week stretch like that was a decade ago. "Although Mr. Musk spends significant time with Tesla and is highly active in our management," says Tesla in its securities filings, "he does not devote his full time and attention to Tesla. For example: Mr. Musk also currently holds management positions at Space Exploration Technologies Corp., X Corp., X.AI Corp., Neuralink Corp. and The Boring Company, and is involved in other ventures and with the Department of Government Efficiency." But also a lot of online gaming, and getting in tedious fights online about his gaming, and other distractions. Still, I assume that a lot of people have short-term trades with theses like "this week he's gonna keep quiet and work and the stock will go up," or "he seems bored, probably this week he's gonna do some wild stuff and the stock will go down." The stock really did go up in May, as Musk left DOGE and promised to spend more time with Tesla. And now this: Tesla Inc. shares fell after Elon Musk announced he's forming a new political party, digging deeper into a pursuit that's been a drag on his most valuable business. The chief executive officer announced over the weekend that he'll take on Republicans and Democrats with the "America Party," focusing on House and Senate seats for the next 12 months. After that, backing a candidate for president isn't out of the question, Musk wrote on X. Tesla's stock slid 8% shortly after the start of regular trading Monday. If that move were to hold, it would be the biggest drop since Musk's initial falling out with Donald Trump over the president's tax bill in early June. Sure! Okay! Whatever! What if your thesis was "Elon Musk's America Party will do great, it will be very popular, it will back great candidates who will win a lot of seats, those candidates will be more generous to electric vehicles than the current government, and ultimately this political endeavor will be good for the business fortunes of Tesla specifically"? Ha ha ha. The market consensus is otherwise. CoreWeave to Buy Core Scientific in $9 Billion Deal. Trump Sets Aug. 1 Tariff Start Ahead of Wednesday Deadline. Private-Equity Fundraising Sputters Through 2025's First Half. Investors pile into tokenised Treasury funds. Andrew Left Set to Appear in Court in Push to Toss Fraud Charges. The Real-Estate Sons Have Taken Over. "If you're looking for work-life balance, this isn't it." Liechtenstein hit by Russia-linked 'zombie trust' crisis. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. 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