Don't Be Fooled by Calls in AvalonBay

Since the market maker is long the stock (a loser in the fall) and short the call (a winner in the decline), it seems that the market-maker has no economic gain. But the market-maker gets to pocket the dividend of 89 cents!

So based on what we just diagrammed, there is clearly a benefit to being short the calls in case any of the open interest fails to exercise. That is all there is to this trade: market makers trying to get short the calls so that they can be a part of the 1,750 contracts of open interest.

So the volume that we see really reflects market makers buying and selling the calls with one another. All of the trades go on the books as opening. The market-makers are smart enough to exercise their calls, and all that is left is anyone who does not exercise.

Investors should be aware of activity such as this so that they do not get fooled into thinking that the options activity will give them some clues about the stock activity. When looking at options activity, particularly deep-in-the-money call (DITM) options, investors should at least be aware of this and other arbitrage activity to make sure that they have a clear picture of the types of risks that people are taking in their stocks.

We see today that the open interest in the January 25 calls is zero, according the OCC's website. So all of the calls were exercised, demonstrating that despite all of that volume, no new open interest was created.

Jud Pyle is the chief investment strategist for Options News Network and the portfolio manager of TheStreet.com Options Alerts. Interested, check out a free trial for Options Alerts. Mr. Pyle writes regularly about options investing for TheStreet.com.