The Jane Street and Optiver cases show the “tail wags the dog” problem, where derivatives become more liquid than the underlying asset, often because regulations or infrastructure restrict direct access, creating an incentive for well-capitalized players to move the thin spot market to influence much larger derivative positions.
In theory, high-frequency arbitrage should close such gaps, but balance sheet limits, technology frictions, and access restrictions mean it often can’t, and manipulation trades look identical to legitimate arbitrage in execution. This dynamic probably already exists in crypto perps and would almost certainly emerge if perps were listed on illiquid assets like pre-IPO stock or private credit, where retail can only trade the derivative but sophisticated players can touch both legs. Derivatives can expand access, but they don’t fix the underlying incompleteness of markets; the real solution is broader access to the original asset.
Jane Street’s Indian Options
In India’s index options market, liquidity is enormous, much bigger than the liquidity of the actual stocks making up the index. This means that if you can nudge the underlying price, you can swing the much larger derivatives market, and make a fortune. That’s what SEBI accuses Jane Street of doing. Their alleged playbook was simple in principle but executed at massive scale.
Step one: buy big chunks of the relatively illiquid underlying index stocks or futures in the morning to push the index higher, making calls more expensive and puts cheap. Step two: take large options positions that would pay off if the index moved in a certain direction, often puts that benefit from a fall in prices. Step three: later in the day, dump those same positions hard, sending the index tumbling, which supercharges the value of the puts. The small loss from buying high and selling low in the underlying is dwarfed by the profit on the derivative side.
Because India’s Bank Nifty and Nifty 50 options trade in huge volumes, with contracts worth multiples of the cash market float, it didn’t take control of the whole market to move the settlement price. A targeted push at key moments, especially right before expiries, could tilt the official close just enough to make hundreds of crores on a single day. That’s why SEBI called Jane Street’s alleged actions “egregious manipulation” and froze nearly $570 million in what it says are ill-gotten gains.
In Jane Street’s defense, the trades SEBI flagged could also be seen as standard cross-market arbitrage within the existing rule set. India’s index derivatives markets are among the deepest in the world, while the cash markets for the underlying index stocks are comparatively thinner. This creates regular price discrepancies between index futures, options, and the spot index level, especially on expiry days when settlement is based on the cash market close. Large, sophisticated firms are uniquely positioned to close these gaps by trading the underlying basket and related derivatives simultaneously. Such flows are fundamental to keeping markets efficient, and in many jurisdictions are considered a normal part of liquidity provision.
The difficulty is that in thinner spot markets, arbitrage activity itself can visibly move prices. To a trading desk, that’s simply the cost of aligning markets; to a regulator reviewing events after the fact, it can appear as deliberate price influence. Without clear, prescriptive limits on how expiry-day liquidity should be provided, firms will naturally operate within the boundaries of what is allowed, optimizing execution for profit while assuming the role of price setter when liquidity is scarce.
In this light, the Jane Street case says as much about the structure of India’s markets as it does about the firm’s strategies. Indeed, the case displayed a structural vulnerability in any market where derivatives massively outweigh the underlying, from commodities to meme stocks to crypto perpetuals.
This is the “tail wags the dog” problem in action: when the derivative market is deep and liquid but the underlying is shallow, price discovery can flip. Instead of derivatives reflecting spot prices, spot prices are manipulated to suit derivatives positions. In theory, arbitrage should correct this instantly, but in practice market frictions, regulatory gaps, speed advantages, fragmented liquidity, mean it’s very hard to police in real time. The point is that deep derivatives liquidity is a double-edged sword. It gives traders powerful hedging and speculation tools, but if the underlying can be cheaply moved, the derivative becomes an instrument not of price discovery but of price control. And when that happens, expiry days turn into high-stakes theatre, where the final act is written not by fundamentals, but by whoever can push the right prices at the right time.
Optiver’s Hammer
In 2007, high-frequency trading firm Optiver developed and used a rapid-fire execution tool nicknamed “The Hammer” in U.S. oil markets. The Commodity Futures Trading Commission (CFTC) later accused the firm of using this tool to influence the settlement prices of crude oil, gasoline, and heating oil futures on the New York Mercantile Exchange (NYMEX). Settlement prices are crucial because they determine the value of expiring futures contracts and many related derivatives, so even small movements at the close can mean large profits or losses for traders with big positions.
According to the CFTC, Optiver’s Chicago trading team used The Hammer to engage in what’s called “banging the close.” This tactic involves executing a large number of trades during the last few minutes of the trading session, in this case, the final three minutes before the market closed. The goal was to push the market price in a particular direction during the short window that determines the official settlement price. In thinly traded moments like this, heavy buying or selling can have an outsized impact on the price print used for settlement.
The alleged scheme worked like this: if Optiver held a position that would profit from a higher settlement price, they would use The Hammer to place aggressive buy orders in the final minutes, pushing the price up. If they stood to gain from a lower settlement, they would instead flood the market with sell orders to push prices down. Because they already had large positions tied to the benchmark settlement, even small shifts in that final price could yield significant gains.
The CFTC’s complaint said this wasn’t an isolated event. Optiver and three named traders allegedly attempted this type of influence on 19 occasions over 11 trading days in March 2007. Internal communications cited in the case, emails and phone recordings, included language like “move,” “whack,” and “bully” the market, suggesting deliberate intent to shift prices. Regulators said the firm also misled NYMEX compliance officials when questioned about these activities, further aggravating the charges.
In total, the CFTC claimed Optiver made about $1 million in profit from these closing-price moves. That might sound small compared to the firm’s annual trading income, hundreds of millions of euros, but the regulator saw it as a significant breach of market integrity. The concern wasn’t just the profit; it was that deliberately influencing the settlement process undermines trust in a benchmark used by many other market participants, from oil companies to airlines hedging fuel costs.
The settlement reached in 2012 required Optiver to disgorge the $1 million profit and pay an additional $13 million civil penalty. It also barred the three traders from trading commodities for periods ranging from two to eight years and restricted the entire firm from trading U.S. oil futures during the settlement window for two years. As is typical in such settlements, Optiver did not admit or deny the allegations.
The “Hammer” episode became a notable example of how concentrated trading in thin, time-sensitive market windows can have outsized effects, and how regulators view such tactics as manipulation if they are designed to move prices rather than respond to them. It also underscored a structural vulnerability: when a benchmark is set in a short, illiquid window, it’s possible for a well-equipped trader to shift it, intentionally or not. This is why settlement procedures and surveillance are a constant focus in futures markets.
The Tail Wagging the Dog
The Jane Street and Optiver cases are both textbook examples of the “tail wags the dog” problem in market structure when the derivatives market becomes deeper and more liquid than the underlying it is supposed to track.
In Jane Street’s case, Indian index options were incredibly liquid because retail traders favored them for leverage. Regulations prevented most retail accounts from accessing high leverage in the cash market, so they poured into derivatives instead. This created a massive pool of liquidity in index options relative to the actual constituent stocks of the Nifty and Bank Nifty indexes. A large, well-financed player could buy or sell those stocks in a coordinated burst, especially near expiry, and nudge the index level enough to swing the value of huge options positions. Optiver’s “Hammer” worked similarly in a different context: during the thin, three-minute settlement window for oil futures, concentrated trading could shift the benchmark price that determined the value of their derivatives positions. In both cases, the derivative leg was the prize, and the spot leg was just a lever to move it.
In theory, high-frequency arbitrage should prevent any manipulative behavior. If someone starts buying in one market, say, the futures, and that pushes the futures price above fair value relative to spot, arbitrageurs should immediately sell the overpriced futures and buy the cheaper spot until prices converge. That’s the textbook no-arbitrage mechanism. In a fully informationally efficient markets with infinite balance sheets, no frictions, and no regulatory constraints, this should make it prohibitively expensive for anyone to keep a derivative mispriced long enough to profit from moving the underlying.
But in practice, these conditions never hold. Arbitrageurs face balance sheet limits, you can’t just warehouse infinite futures shorts and spot longs without capital constraints. They face technology limits, not everyone is co-located at every venue or able to update prices in microseconds. And they face regulatory limits, certain participants can’t touch the spot market at all, or can’t short it, or are subject to position limits. Those frictions mean that even obvious pricing gaps can persist long enough for a well-capitalized, fast-moving player to exploit them. The bigger and more persistent the gap in liquidity between derivatives and spot, the easier it is to push things around.
The real kicker is that the trading pattern for manipulation and for legitimate arbitrage are identical. Suppose someone is trying to push the futures price down by selling a lot of futures and selling the underlying stocks that make up the index. The textbook “fair value” arbitrage to bring prices back in line would be… buying the futures and buying the stocks! From the perspective of an exchange or regulator looking at order flow, the sequence of trades looks exactly the same (but just in opposite directions) whether you are correcting a mispricing or deliberately creating one. All you can see is aggressive trades in both legs; you can’t infer the intent.
This is why enforcement is so hard in TradFi and essentially nonexistent in DeFi. Regulators can only act after the fact, when they piece together positions, timing, and communications to infer intent. In real time, the market just sees a large player “leaning” on both markets, which could be an honest arbitrage push toward fair value or an intentional distortion to benefit a bigger derivatives book. The mechanics are indistinguishable; the difference is in motive, and motive isn’t in the trade data.
The same dynamics probably already exists in crypto perpetual futures, which are far more liquid than spot in many markets because crypto lending is underdeveloped; retail traders can’t easily borrow large amounts of BTC or ETH to short, but they can take large leveraged perp positions. Market makers and prop desks don’t have this problem: they can borrow spot, access OTC liquidity, and trade on every major venue. This asymmetry means they can run cross-market strategies similar to what Jane Street allegedly did in India, using spot or illiquid venues to shift the reference price that drives their much larger perp book. Given the lack of regulation and surveillance in crypto, it’s likely that such tactics already happen regularly.
If we start listing perps on illiquid assets, like pre-IPO stocks, private equity funds, private credit portfolios, art indexes, or collectibles, the setup for “tail wags the dog” manipulation becomes even more pronounced. People will flock to perps because they can’t access the actual asset: they can’t trade on Nasdaq Private Market, buy a stake in a PE fund, or bid on an art auction. But sophisticated players who do have access to the underlying can buy or sell in that thin, slow-moving spot market and move the reference price, even slightly, to tilt the much larger perp market in their favor.
The fundamental asymmetry is this: one group has access to both legs of the trade, while the other group has access only to the derivative leg whose price depends on the one they can’t touch. You’re fighting with one hand tied behind your back. In TradFi, this is an unsolved problem; regulators try to monitor markets, detect manipulation, and impose fines after the fact. In DeFi, there’s often no enforcement at all. The onus is on protocol design to make benchmarks harder to game, something most current markets don’t solve.
This doesn’t mean creating DeFi derivatives on previously inaccessible assets is a bad idea. If the underlying asset class appreciates over time ,say pre-IPO tech stocks in a growth phase, both retail and sophisticated players can benefit: retail gets exposure they previously couldn’t, and pros get a new market to trade. In a growing economy, that can be a genuine win-win.
But empirically, the picture can be less rosy. In India, the indexes themselves have risen in recent years, yet retail options traders have lost far more money than if they had simply bought and held index ETFs. The combination of high derivatives liquidity, spot market thinness, and asymmetric access gives sophisticated traders structural opportunities to extract value, and in zero-sum derivatives markets, that value comes from the other side’s pocket. Without structural safeguards, the same story is likely to repeat anywhere derivatives outgrow their underlyings, whether it’s in oil, index options, crypto perps, or tokenized private assets.
Preventative Measures
While it is probably impossible to eliminate market manipulation entirely, one can try managing it so markets remain fair enough to function and grow. In traditional finance, the balance is kept through better benchmark design, position limits, and active surveillance. Exchanges move away from thin settlement windows to VWAP or TWAP calculations, making it harder to shift a benchmark with a single burst of trading. Position caps limit how much exposure any one participant can carry into expiry relative to underlying liquidity. Surveillance systems flag suspicious expiry-day patterns, and large fines increase the cost of manipulation. These measures don’t remove the incentive to game the system, but they raise the bar high enough that it becomes an occasional risk rather than a daily reality.
In crypto and DeFi, there is no regulator to wield that stick, so the solution has to be engineered into the market’s design. That means building manipulation-resistant oracles that draw from multiple venues and time-weighted prices, rather than a single tick. It may also mean constraining perp and option open interest relative to the liquidity in the underlying spot markets. DEXs may want to align incentives so large liquidity providers and sophisticated traders have a stake in market integrity, not just short-term extraction. With these protections, perps on thin or inaccessible assets, whether pre-IPO equity, private credit, or art indexes, can still give people exposure they couldn’t get before without becoming a playground for one-sided exploitation.
But the deeper truth here is that markets are fundamentally incomplete when not everyone can trade everything. Many of the imbalances that let the tail wag the dog arise because access to the “dog” itself, the original asset, is restricted. In India, retail couldn’t lever spot positions, so they crowded into derivatives. In crypto (and to an extent, TradFi), weak lending infrastructure drives traders into perps (futures). In private markets, the very assets aren’t accessible at all to most participants.
Derivatives can be a useful add-on for accessibility, a bridge that gives people partial economic exposure, but they are never a full substitute for owning and trading the underlying. The long-term goal should be broader access to the original thing, so derivatives complement a complete market rather than replace it. Until then, any derivatives market on an inaccessible or illiquid underlying will carry the same structural vulnerability: the party with access to both legs will always have an advantage over the party with only one. The best we can do is design systems that make that advantage harder to exploit, and broad enough access that the dog, not the tail, leads the way
Disclaimer
The information provided on TheLogbook (the "Substack") is strictly for informational and educational purposes only and should not be considered as investment or financial advice. The author is not a licensed financial advisor or tax professional and is not offering any professional services through this Substack. Investing in financial markets involves substantial risk, including possible loss of principal. Past performance is not indicative of future results. The author makes no representations or warranties about the completeness, accuracy, reliability, suitability, or availability of the information provided.
This Substack may contain links to external websites not affiliated with the author, and the accuracy of information on these sites is not guaranteed. Nothing contained in this Substack constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments. Always seek the advice of a qualified financial advisor before making any investment decisions.
