Long stocks = short synthetic put?
My worry was that as the index approached 4,100 or higher, the threat of intense selling by capital-tight brokers at 4,500 meant that anyone buying shares was implicitly giving away a free call at 4,500, and the higher prices went, the less upside there was and the more downside. Remember that if you are long the underlying asset and short a call option, you are effectively short a synthetic put option struck at the same price as the call option. This means that anyone who owns shares might in fact be short a complex synthetic put option on the market, and as the put becomes increasingly less out of the money (i.e. as the index approaches 4,500), the value of the put rises, and so the loss to the implicit “writer” of the put would also rise. If the writer of the put can cancel the option at no cost, the rational thing for him to do would be to cancel it. In fact he can do so simply by closing out his long position and selling his shares. By the way the fact that most investors do not understand option theory is irrelevant. The option framework predicts how investors will behave as long as they understand that a lot of selling puts downward pressure on prices and a lot of buying upward pressure, and in a purely speculative market, this is pretty much the only thing investors have to understand.