Michael Shulman

   

Bottom line: Despite what happened last week, shorting -- in all of its forms, whether it's short-selling stocks, buying puts, or selling calls and puts -- is integral to the liquidity and functioning of the market.

Fortunately, it's not going away -- but it's been knocked down a peg and the hurt is going to spread. We already saw that in the options markets today.

Consider that options -- put options in particular -- are essentially insurance for the financial market. We need market-makers in the options realm to supply a kind of safety net for portfolios. Of course, if they reduce some of the risk for investors like you and me by writing put options, they must offset some of the risk they take on for hedging that bet.

In normal markets (whatever those are anymore) the market-makers would diffuse some of their risk from offering put options by short-selling the underlying stock.

Now, of course, they can't do that (at least in the financial sector domestically). That means there is all of this extra risk floating around with nowhere to go except to artificially inflate prices. In the same way that gas prices often increase when there is a "perceived threat" from a forecast storm, put premiums have elevated to ridiculous levels.

I'm as patriotic as the day is long, but here is where we should've taken a cue from the United Kingdom. While it enacted a similar ban on short-selling financial names, U.K. options market-makers are still allowed to short-sell as a way to offset some of the risk they take on.

WHERE DO WE GO FROM HERE?

"Coulda, woulda, shoulda," well, ain't gonna to help us now.

Unable to perform their usual protection duties and with options traders still demanding to buy puts and sell calls, the market-makers' hands are tied -- and it's got the options markets tied in knots.

Their ability to short stock against their option positions is an essential piece of what they do. Without that piece, the system is off-kilter.

We're already seeing the effects. Today's negative close came about, in part, because the market-makers have nowhere to seek shelter, so to speak, and put options' values have mounted as a result.

The good news, of course, is that even with the government's ban, you can still profit from playing the short side of the financials by buying put options. The bad news is that, at least in the interim, you're likely to pay a lot more for them.

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