This paper studies a new theory for pricing options in a large trader
economy. This theory necessitates studying the impact that derivative
security markets have on market manipulation. In an economy with a sto
ck, money market account, and a derivative security, it is shown, by e
xample, that the introduction of the derivative security generates mar
ket manipulation trading strategies that would otherwise not exist. A
sufficient condition is provided on the price process such that no add
itional market manipulation trading strategies are introduced by a der
ivative security. Options are priced under this condition, where it is
shown that the standard binomial option model still applies but with
random volatilities.