Uptick Rule Comes to Married Puts

New SEC guidelines are meant to prevent a strategy for driving a stock lower.
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Updated from 2:38 p.m. EST

A trading strategy that's sometimes used to get around rules that prevent bears from driving stocks down through excessive selling is probably history under a new

Securities and Exchange Commission

regulation.

The agency issued new guidelines Tuesday governing the treatment of so-called married puts: trades in which an investor simultaneously buys a stock and a put option, which becomes valuable it the stock falls.

In the vast majority of cases such a strategy is an above-board way of hedging against the possibility a stock loses value. The new SEC rules are intended to prevent an esoteric abuse of the strategy by an investor who is, on balance, betting the price goes down.

Normally, short sales, in which borrowed shares are sold in the hope they will fall , can only be carried out on an "uptick" -- after the price of the stock has risen. The rule is intended to prevent short sellers from piling into shares that are already in descent and exacerbating their fall.

Until now, the uptick rule has not applied to a seller of shares that are part of a married put position. Under the new guidelines, an investor holding a married put who wants to sell the long position will be considered short the stock, and will have to wait for an uptick before unloading.

"Some strategies may involve the manipulative sale of securities underlying a married put as a part of a scheme to drive the market price down and later profit by purchasing the securities at a depressed price," the agency said.

That variation could be best applied on thinly traded stocks, where a 10-cent price movement could make a significant difference to a trader and the stock was vulnerable to price manipulation.

"Over the last couple years, the commission became aware of situations where married puts were being abused," said John Heine, a spokesman for the SEC. "There was a variety of opinions and schools of though about whether such transactions were legitimate or not, in the marketplace and at the bar, among securities lawyers. The SEC thought it was best to issue an interpretive ruling that could be clearly understood."

Scott Rothbort, president of LakeView Asset Management and a contributor to

TheStreet.com's

professional investor sister site,

Street Insight

, said the SEC had made a critical distinction between a legitimate hedging strategy and the use of married puts as a way to evade short-selling rules, particularly with secondary offerings. The SEC rule is that short sales can't be covered with offering securities if the short sale happened five days before the pricing, or the period from filing to registration, whichever is shorter.

"It's clearly been up to now a practice in the gray area," Rothbort said. "They've put the stake in the ground and people now know how they can or can't use it. If they have it for a reasonable duration the SEC is saying it's considered a hedged transaction, not a sham married put transaction. The key here is the holding period."