View Full Version : Potential to abuse path-dependant options

03-28-2005, 07:55 PM
First of all, I would really appreciate a response from someone in the options dealing industry who would know what regulations are in place to avoid this abuse of path-depandant options.

I came across this in my derivatives course, and found it quite interesting.

Basically, path-dependant options are options where the ultimate payoff is a function not only of the underlying asset price at expiration, but also of the "path" it took to get there. One of these is a lookback option, where the value is based on the maximum intrinsic value of the option (underlying asset value - strike price) at ANY time during the options life.

With path-dependant options like these, is there potentially a way to abuse the system? Essentially, you would purchase MANY lookback options on a single stock. Then, at some point during the life of your option, you make a bid for the underlying stock at some astronomical price. (i.e., if the stock price is $40, make a bid for $80). Someone will sell their stock to you at $80, and the stock charts will reconize a huge jump in the stock price from $40 to $80. At this point, your lookback options are worth TONS, and all it cost you was $80.

I am sure that this cannot exist. It's just too simple, and too easy to do. Could someone in the options industry explain to me why this is, in practice, not possible? You could undertake similar actions on ANY path-dependant options and it just does not seem right.

Any comments welcome.