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Options Trading Surfaces In Madoff Fraud

Analyst warns that liquidity in the options contracts that Madoff was trading could not have supported the total assets ($17 billion) that he allegedly managed.

As new details emerge from Bernard Madoff's alleged investment fraud, today's Commenting on the article's findings, Andy Nybo, senior analyst at TABB Group In New York, who is an expert in options trading, agreed there was not enough liquidity in the options contracts to support Madoff's strategy for $17 billion in assets under management.

"The options liquidity could not support his scale of strategy if his strategy was replicated across all the accounts," says Nybo. He contends there were red flags in the customer statements that should have tipped off an institutional investor if they were doing their due diligence. "A large investor with a large enough position, would have been able to take a look at the trading volumes in the marketplace for that particular point of time and would have seen some discrepancy from the trading volume in the statement and what was occurring in the marketplace," said Nybo. "The amount of trading that would have to be in force, could not have been supported by the instruments that he was allegedly trading in," says Nybo.

In an example in the article, on Nov. 11, Madoff only used 11 contracts to hedge a half million dollars, but experts said it would have taken 22,000 contracts to protect $1 billion, and Madoff supposedly was managing $17 billion. But the open interest (or measure of contracts outstanding) was 4,639 contracts, according to the CBOE, which implies that there wasn't enough liquidity in the contracts to cover all of assets.

"Though he was moving billions of dollars through the market on a frequent basis, it didn't seem to be appearing anywhere," observes Nybo. On the other hand, it's possible that Madoff went to the over-the-counter derivatives market, says Nybo. "When an options trader can't get the liquidity he needs, he potentially turns to the over-the-counter markets," says the analyst.

An unnamed source in the WSJ article said the firm did said Madoff's firm bought and sold options off-exchange, but the article expresses doubt on whether the OTC market could support the volumes the firm was reporting.

Nybo says he finds it amazing that fund-of-funds "with hundreds of millions of dollars or billions of dollars didn't dig deeper. "You would think that you would sacrifice a little bit of that capital to investigate what you are investing in. This is all pointing the finger at operational risk errors that are occurring at a number of large firms," says the analyst.

However, Nybo suggests that the article's headline, "Madoff Ran Vast Options Game," is somewhat sensational. "He was running a pyramid scheme," says Nybo, referring to the practice of Madoff allegedly using money that was coming in from new investors to pay returns to existing investors. "Just to equate it to an options scheme is not the totality, comments Nybo.Analyst warns that liquidity in the options contracts that Madoff was trading could not have supported the total assets ($17 billion) that he allegedly managed. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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