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i was actually being conservative. The spike in volatility could potentially push even the first set of options (in the example) into positive territory. I trade options almost exclusively, particularly over the last two years of this credit crisis. I am quite familiar with their behavior during price spikes and short squeezes. What the market makers due when volatility get's too rough for comfort is to bring their market making activities closer in the horizon curve. If you notice, for the very, very volatile stocks it is quite difficult to get LEAPs or long term expiries, despite the ample liquidity in the underlying. From many of those stocks, 6 months is about as far as you can go.

Market makers hedge with offsetting options, not the actual underlying, so the short squeeze does not dry up the availability of options. What it may do is allow some "gun to the head, give me all of your money" style bid-ask spreads, though. But think about the VW example. At nearly 1,000, I'll give you your 3 dollar spread. It's a cost of doing business, and it would be very easy for your profits to justify the spread on the way back down to the equilibrium line of 200, which is exactly where VW ag took off from and exactly where it landed.