Revisited: The Case For Manipulation Of Sears Holdings

Mar.27.12 | About: Sears Holdings (SHLD)

Last Friday (March 16, 2012) I published an article entitled "Sears Holdings: A Comparison to Manipulated Stocks." The movement of the Sears Holdings (NASDAQ:SHLD) share price for the past week has highlighted some of the key passages in the previous piece.

Movement Toward Option Strikes

Quoted from the study, "Do Hedge Funds Manipulate Stock Prices?" (pdf) in the previous article:

Ni, Pearson, and Poteshman (2005) report that stocks tend to cluster around option strike prices on expiration dates.

The March 2012 options expired on 3/16/12. The closing price of SHLD on this date was $82.55, a mere .05 cents away from an option strike. It also managed this on the second highest volume day of the month, about 42% higher than the average for March. The highest day of volume was on 3/2/12, a weekly option expiration day which saw an intraday spread of 8.06.

As I noted in the previous article, the stock followed its option pattern again:

The last five expiration Fridays for Sears have closed at the following prices: 2/17/12: 54.53, 1/20/12: 49.00 (up 13%), 12/16/11: 46.16 (down 8.46%), 11/18/11: 64.27, 10/21/11: 74.95. Looking at the movements and reversals in the share price for the last three months, they appear to correspond with the end of the month or the end of the week (Sears has weekly options).

According to OptionCalc, the max pain for the 3/30/12 weekly options is $75, with $77.5 a close second. The previous Friday closed at $72.36 so there would need to be a reversal during the week to reach either number. The max pain for the 3/16/12 options was $82.50 (a .05 difference). If the stock looks like it is slowing heading back up it may find itself in this range. Caution should still be exercised as the stock has been known to make strong movements without much volume.

Failure to Deliver

The site Fails to Deliver tracks the most recent delivery failures for a stock as reported by the SEC. These failures occur when a stock appears to have been exchanged between two parties but is later reported as never having been closed out. Which means one party failed to deliver the shares to the other, though it had previously appeared to. These delivery failures are often attributed to attempts to drive a price down via naked shorting. There is, however, research to show that delivery failures can result in price increases.

Quoted from the study "Failures to Deliver, Short Sale Constraints, and Stock Overvaluation":

Studying a large sample of publicly available data on failures to deliver, we find that stocks reaching threshold levels of failures become significantly overvalued. Where short sale constraints are especially binding, we report extreme overpricing and subsequent reversals. These findings support the overvaluation hypothesis, although the mispricing is likely to be difficult to arbitrage because of extreme shorting costs.

This is to be expected, as shorting contributes to selling, which forces the price down. Anyone who went or tried to go short against SHLD was met with high premiums. These of course can act as a catalyst to the stock price because fewer people bet against it. Where Sears Holdings differed was the level of institutional ownership. The study noted that high levels of ownership correspond to stocks that are easier to short because of the liquidity provided by the institutions.

Institutional ownership is negatively related to the likelihood of being special because institutional investors serve as a significant source of supply in the stock lending market, making stocks held by institutions less costly to borrow.

The implication is that the institutions who own 91.3% of Sears Holdings were not selling or lending their stock, as the lending costs were so high. Had these institutions allowed their shares to be freely borrowed the premium would not have cost so much. When people cannot short a stock, due to either a lack of availability or high premiums, what can they do? They can use options to start a short position against the stock, either by writing calls or buying puts. This is where the delivery failures come into play. Naked shorting is generally seen an activity that lowers the price of a stock, but it can contribute to raising the price as well. The next article will explain how an official options market maker can influence the price, and make a tidy profit, by way of delivery failures.

Price vs Delivery Failures vs VolumeClick to enlarge
Delivery Failures (black) and share price (red) from 1/3/12 to 2/29/12. The dark black line is shifted two days back to reflect the timing of the original transaction. All numbers are reflected as a percentage of their totals.

Statistics were taken from Fails to Deliver and the NASDAQ historical SHLD quote page.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: While Eddie Lampert, Bruce Berkowitz, and Goldman Sachs (GS) were mentioned in the previous article concerning a possible manipluation of Sears Holdings, there is no direct evidence to suggest they are responsible for the possible manipluation, if there is any at all.