4 ms·

If the type of trading discussed in the article becomes more common, would market makers stop making markets for these deep out of the money options? Presumably

If the type of trading discussed in the article becomes more common, would market makers stop making markets for these deep out of the money options? Presumably this would be bad for those attempting to use the options as a hedge.

patio11 11y ago
They aren't allowed to stop making markets, at least in the options market. (This is not true of market makers generally. You or I could, if we had a lot of money, start making markets in any stock we desired to, just by getting a brokerage account and sending the right orders to the exchange. A market maker is a participant like any other and may not be a formal role.) What would probably happen is tweaking their risk exposure: be less willing to play large resting bids/asks for large positions close to the NBBO, and instead either resize them or layer them over several price points. My feeling with regards to the fairness of this is that one should not offer to sell 4,000 PUTS for e.g. Zynga at $1 in May 2015 unless one is prepared to accept delivery of 400k shares of Zynga in return for $400k. Some options market participant is signaling their willingness to do that, or something close to it. They are theoretically responsible adults who know the risks. If that trade blows up in their face, and they take to the Internet to decry the unfairness of it all, I will not be maximally sympathetic. (Full disclosure: I was probably their counterparty a time or two buying the option on "Zynga blows up in next short-increment-of-time" and did poorly.)
- rustyconover 11y ago
  They could make the spread wider after the first 500 contracts go off in a certain interval. Even the in the S&P outcry pit in Chicago sometimes the bid/ask spread goes wide or even no bid when things move too far or too fast for comfort. Next time a jobs number comes out or other financial data point look at the spread right before the number is released. These marker makers are survivors, if they're nervous about inventory risk they shrink size and you get thinner markets (bid/ask sizes) or wider spreads. Of course, if the options market shows something very out of sync with the underlying that is a signal that something is up or there is a market force that hasn't yet caused the underlying to move. Because an American option can be exercised anytime before expiration both options and the underlying stay pretty closely aligned with each other using the theoretical pricing model of each market maker. I'm sure this trader has programmers working on this problem and putting in some type of limiting such that he doesn't sell off 3000 contracts in one go for a very cheap option close to expiration. 3000 contracts is nothing in SPY options but for a single name stock (not an ETF) it can be considered a sizable trade compared to the open interest.
- wglb 11y ago
  There is a subset of market makers in NYSE stocks, for example, that have contracts with the exchanges that require them to stay in the market regardless of how bad things are. I know of one such firm that did quite well on the upswing part of the flash crash, as other big firms bailed.

patio11 11y ago

They aren't allowed to stop making markets, at least in the options market. (This is not true of market makers generally. You or I could, if we had a lot of money, start making markets in any stock we desired to, just by getting a brokerage account and sending the right orders to the exchange. A market maker is a participant like any other and may not be a formal role.) What would probably happen is tweaking their risk exposure: be less willing to play large resting bids/asks for large positions close to the NBBO, and instead either resize them or layer them over several price points. My feeling with regards to the fairness of this is that one should not offer to sell 4,000 PUTS for e.g. Zynga at $1 in May 2015 unless one is prepared to accept delivery of 400k shares of Zynga in return for $400k. Some options market participant is signaling their willingness to do that, or something close to it. They are theoretically responsible adults who know the risks. If that trade blows up in their face, and they take to the Internet to decry the unfairness of it all, I will not be maximally sympathetic. (Full disclosure: I was probably their counterparty a time or two buying the option on "Zynga blows up in next short-increment-of-time" and did poorly.)

rustyconover 11y ago
They could make the spread wider after the first 500 contracts go off in a certain interval. Even the in the S&P outcry pit in Chicago sometimes the bid/ask spread goes wide or even no bid when things move too far or too fast for comfort. Next time a jobs number comes out or other financial data point look at the spread right before the number is released. These marker makers are survivors, if they're nervous about inventory risk they shrink size and you get thinner markets (bid/ask sizes) or wider spreads. Of course, if the options market shows something very out of sync with the underlying that is a signal that something is up or there is a market force that hasn't yet caused the underlying to move. Because an American option can be exercised anytime before expiration both options and the underlying stay pretty closely aligned with each other using the theoretical pricing model of each market maker. I'm sure this trader has programmers working on this problem and putting in some type of limiting such that he doesn't sell off 3000 contracts in one go for a very cheap option close to expiration. 3000 contracts is nothing in SPY options but for a single name stock (not an ETF) it can be considered a sizable trade compared to the open interest.
wglb 11y ago
There is a subset of market makers in NYSE stocks, for example, that have contracts with the exchanges that require them to stay in the market regardless of how bad things are. I know of one such firm that did quite well on the upswing part of the flash crash, as other big firms bailed.