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How credible is the suggestion that specific parties distort price discovery (rig the market) of a given asset by buying/selling corresponding futures contracts or any other derivatives.

Should these position not unwind at some point causing a reversal effect?

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Can futures buying/selling distort price discovery?

Yes, that is plausible although will not necessarily be the case. I will focus on put & call options.

Consider the put-call parity, which I rewrite as

$$S+P=C+K*exp(-rt)$$

where S denotes the stock [price], P put, C call, and K the strike price.

Buying enough call options will increase C. If that were the only change in the market (regarding this stock), that would "break" the put-call parity and therefore an arbitrage opportunity would ensue.

Since K is fixed, the only possible changes to offset C's increase are an increase of P and/or of S. An agent who notices C going up is likely to interpret that someone else has information in the sense that S will go up.

Unless that agent also has information in the opposite direction, it would be irrational for him to buy P in his attempt to take advantage of the arbitrage opportunity. Thus, he is likelier to buy S instead of P at least while the put-call parity is restored. Buying S tends increase its price (as is the case with any financial instrument).

Similarly, in the event of C's increase, the agent might set up a strategy that consists of taking a short position on C and hedge it by taking a long position on S (he might have to borrow because C<S, but that is irrelevant to the point). Opening that long position tends to increase S.

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  • $\begingroup$ Can you comment on short vs long term effect? Especially with regard to my last sentence? $\endgroup$ – Frank Rem Feb 11 at 9:15
  • $\begingroup$ @FrankRem Reversal/unwinding effects are hard to foretell, more so in the long term. But if buying C causes enough increase in S, then exercising in-the-money Calls at expiry cannot push S down: to the extent that the seller of these options shall honor its obligation, the demand of S is non-decreasing. If buying P brings S down, the effect (on S) of exercising ITM Puts at expiry may depend on whether the options buyer owns stock to deliver them when exercising his Puts. Subsequent reversals and/or contagions depend on the new stockowner's pace & timing for transacting S. $\endgroup$ – Iñaki Viggers Feb 11 at 11:21

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