Why Adding an Option to Offset Your Own Market Impact May Fail

Summary

The document considers whether a trader executing a large stock sale should also buy a put to benefit from any downward price impact caused by the sale. The proposed idea is framed as profiting from one’s own impact while completing an intended equity trade. The response rejects the argument as economically inconsistent: it assumes both that the derivative can be traded with enough liquidity to execute its delta and that the stock order can move the market.

Bid–ask spreads and transaction costs also matter to the proposed trade. The exchange does not provide a quantitative model, impact estimate, or conditions under which a hedge might be worthwhile, so the conclusion is a brief critique rather than a general execution strategy. Assessing such a position would require accounting for liquidity in both instruments, the actual impact of the stock order, option pricing and hedge mechanics, and all associated costs. The example alone does not establish that market impact is predictable or that a derivative purchase can capture it profitably.

Key ideas

• The proposal is to buy a put while selling stock in order to benefit from the sale's possible price impact.
• The response identifies a tension between assuming derivative liquidity and assuming the stock order moves the market.
• Bid–ask spreads and transaction costs can undermine the proposed offsetting trade.
• The document gives no quantitative model for estimating impact or determining when a hedge is worthwhile.

Tags

# Self-Frontrunning Arbitrage


# Self-Frontrunning Arbitrage












If I have a large order to fill, shouldn't I always buy a derivative in the same direction to profit from the market impact?

E.g. I sell 1 million shares and so I buy a put, which will hence almost surely increase in value (due to large market impact).

I understand that I lose value from selling shares as the price goes down, but my point is more about always adding the put (assuming I want to sell the shares anyways)? It would be a kind of self-frontrunning strategy.

## Answer by Tulio Carnelossi (score 1, accepted)

https://quant.stackexchange.com/a/19170

Just take a look at the bid ask spreads plus transaction costs. It's nonsense what you are saying because on one side you implicitly assume enough liquidity so you market maker executes the Delta of your position. On the other hand you assume the market is liquid so you can move the market when you sell your position.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.