# This spread is criminal!



## GreatPig (15 November 2006)

How can the MM get away with this???

BSL has shot up over 8% and the MM now has a buy-sell spread on a call warrant of 27 cents vs 47 cents, while BSL itself only has a one cent spread.

I want to sell the warrant, but by my calculations it should currently be worth around 37 cents. In fact it was showing 36 cents when I first noticed it, but a few seconds later when I refreshed it had dropped to 27 cents.

Surely they can't be allowed these sorts of spreads?

GP


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## GreatPig (15 November 2006)

Okay, now BSL has dropped a little they're showing 35.5 cents and 36 cents.

That's more like it.

Edit: out at 34.5 cents.

GP


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## Kauri (15 November 2006)

GP..

  Not sure but MM might have been running scared, the ASX50 took a sharp dive around that time???


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## GreatPig (15 November 2006)

BSL was just on $8 when I noticed it and wanted to sell, which should have had the warrant at around 37 cents. By the time the spread got back to something reasonable, BSL was back under $7.90 so all I got was 34.5 cents (still a 46% profit, but it's the principle that counts).

It's back in the $7.90s now with the warrant back at 36 cents, but $8 looks like quite a strong resistence level.

GP


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## SevenFX (15 November 2006)

Silly question GP,

I'm trying to learn cfd's slowly, and wondered if you are referring to MM being "MarketMakers" (like CMC) that can control the spread (which can also see everyone's position of course) and not DMA (like eTrade) which spread is actually goverened by physical stock (investor/trader)...

Have I got that right, as I was leaning towards joining DMA provider because of this reason...

Also who regulates CFD providers, consumer affairs, asic or no regulation at all...????

Thanks
SevenFX


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## Kauri (15 November 2006)

GP..
           Great trade, I tried warrants and couldn't get my head around them.
   Tekman, 
            Warrants and CFD,s are different instruments. MM is market maker.


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## GreatPig (15 November 2006)

Kauri said:
			
		

> Great trade



About time is all I can say 

GP


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## cuttlefish (15 November 2006)

This is the big challenge of trading warrants and options - the dependency on the market makers.  My experience from the options trading I've done (and I've decided to leave them alone except for very specific situations) is that the theoretical extra leverage you get from options actually gets eroded by the large spread cost you have to pay due to lack of liquidity.

So basically unless you day trade (or short time frame trade) a highly liquid options or warrants series where the market is made up of other traders as well as the MM's, I'm not convinced they're a great idea. 

My thinking has moved to allocating more capital and doing larger trades on the underlying as a better way to leverage a trade though with that approach the fat tail risk is there which you are at least protected from via options or warrants.

In relation to getting a decent price, something I have found is that if you place an order out there at or above the theoretical price (if selling) or below if buying, you'll often find another trader or the MM will come out and put a counter in place - if you slowly move your order down you might find someone either jumps on your price, or comes out of the woodwork with a more reasonable counter.

The other factor is to be very aware of is the influence of greeks when trading warrants or options because this will affect the prices and spreads and can also explain why a MM won't give the price you expect.

If your trading is reliant on MM's obeying the 'rules' then you will not do well with options or warrants - you need to be assuming the MM's are completely unhelpful and will not give you a price unless they see a genuine arbitrage opportunity IMO.


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## Magdoran (15 November 2006)

GreatPig said:
			
		

> How can the MM get away with this???
> 
> BSL has shot up over 8% and the MM now has a buy-sell spread on a call warrant of 27 cents vs 47 cents, while BSL itself only has a one cent spread.
> 
> ...



I feel for you GP.


Well done on an excellent trade!

This kind of market maker behaviour is in part why I moved over to options for position trading, but still see instalment and endowment warrants as a potentially a good longer term growth and income generating instrument.  Of course there is a lot of due diligence required to trade these.

I’m not sure why the MM wasn’t making a market at one point.  They are allowed some leeway in large moves under certain conditions.  This can be frustrating when there isn’t a natural market, especially with relatively low open interest instruments.

Part of the problem from what I could see was the delta and the ratio of the warrant.  This makes it really hard to calculate the value of this kind of warrant, especially when the time value is different to options.  The volatility is also engineered, which can be disadvantageous sometimes when it works against you.  You really need to study the matrix they put out, and they can and do change these from time to time.

When I traded warrants a lot a few years ago when options weren’t as liquid as they are now, I made it a point to study the various terms and conditions, and I found some warrant providers were better to trade then others.  Just join the dots, and you may get what I’m hinting at here.  You’ll find if you trade these a lot some issuers are better to deal with then others.


Regards


Magdoran


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## wayneL (15 November 2006)

cuttlefish said:
			
		

> This is the big challenge of trading warrants and options - the dependency on the market makers.  My experience from the options trading I've done (and I've decided to leave them alone except for very specific situations) is that the theoretical extra leverage you get from options actually gets eroded by the large spread cost you have to pay due to lack of liquidity.
> 
> So basically unless you day trade (or short time frame trade) a highly liquid options or warrants series where the market is made up of other traders as well as the MM's, I'm not convinced they're a great idea.
> 
> ...




Hi cuttlefish,

If using options strictly for leverage on directional trades, then yes the spread is an impost (together with commish, termed "contest risk") that is hard to justify.

I agree this is not the best use of options. Magdoran might disagree, but he would concede that a different _modus operandi_ is required than that of a straight share (or cfd) trader.

The reality of options is that you are not just trading delta (direction), you are trading 5 other price outputs as well (gamma, theta, sigma, vega and in volatile interest rate environments, rho) 

For instance I put a bearish strategy over the SP500 the other day. Recognising it was putting a penny on the track in front of a freight train, I wanted a strategy that was short delta, long gamma, long vega on the downside, but theta positive and long delta on the upside.

This means if I was wrong about direction (which I was spectacularly so) I would still come away with a profit and I have.

That strategy was a put backspread. I wasn't just trading direction.


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## Magdoran (15 November 2006)

wayneL said:
			
		

> Hi cuttlefish,
> 
> If using options strictly for leverage on directional trades, then yes the spread is an impost (together with commish, termed "contest risk") that is hard to justify.
> 
> ...




Certainly there is an art to trading straight call or put options directionally.  Wayne is quite right about the contest risk since you will make a loss if you exit straight away because of the spread.

Options trade very differently from shares, and to a large extent from CFDs.  Volatility and delta are very important in trading straight options directionally, and can make a hell of a difference to the result.  But this is part of the nature of the instrument.  If you can use this effectively to your advantage, you can enhance rewards and limit losses, but there is a lot to doing this effectively.

But if you trade an OTM position with the right set up, and the underlying moves in the money, the problems with liquidity and spread can become marginal – sure you can lose some theoretical value, but often this becomes a small percentage of the overall profit.  You have to accept that part of the cost of doing business is the slippage and brokerage.


Regards


Magdoran


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## wayneL (15 November 2006)

BTW.. and just continuing on from Mags comments:

In the trade I mentioned, if I was more sure that the SP was going to dump, there is no better strategy than the staright out put (at that point in time that is)

If it had worked as intended, the puts, on a delta for delta basis would have outperformed the futures big time.

Why? IVs are gang-nailed to the bottom of their range ATM. Long puts are short delta, long gamma (with heaps of it on tap), and long vega... bewdiful!

Just saying there are times when there is no better trade than a straight out option.


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## wayneL (15 November 2006)

Further comments re the spread:

Not such an issue with the instruments i trade. SP500 futures spread is 1 tick nearly all the time. The options generally have a spread of 2 or 3 ticks (sometimes 1 tick)... so not so much of a big deal.

Other futures options have a wider spread, but most generally pretty good. I often split the bid ask spread and get picked up straight away as well.

It's all fun and games.


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## GreatPig (15 November 2006)

Just took a look at the PDS for that series of warrants from Citigroup and noticed the following under the section on liquidity:



> However, there are no spread on quantity obligations applied to the market making requirements. The quality of market making will depend on competitive pressures. In times of extreme volatility the ability of market makers to maintain a market will be put under stress. Investors should be aware that in these situations, the presence of quotes suitable to your particular requirements in the market cannot always be assured.



Sounds like a "we'll make a market as long as it doesn't cost us too much money" clause 

GP


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## markrmau (15 November 2006)

FWIW, watching the underlying and warrant real time, I believe abnamro warrants are best. 

Another reason the spread may temporarily be poor is that there are insufficient bids or offers on the underlying for the MM to hedge.

Cheers,Mark.


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## Mofra (16 November 2006)

markrmau said:
			
		

> Another reason the spread may temporarily be poor is that there are insufficient bids or offers on the underlying for the MM to hedge.



May sound like a silly question, but how do Warrant MMs hedge their position?
Is it in the same manner as ETO MMs ie equivalent positions to conversions & reversals?


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## Magdoran (16 November 2006)

Mofra said:
			
		

> May sound like a silly question, but how do Warrant MMs hedge their position?
> Is it in the same manner as ETO MMs ie equivalent positions to conversions & reversals?



Hello Mofra,


Warrant issuers may hedge in a number of ways, but generally buy the stock on your behalf and place it in trust for you with most call warrants, particularly instalment and endowment warrants.

A lot depends on the internal policies of the issuing body.  Some may have a wider strategy and position net long or short the underlying stock, but many will just buy the stock and hold it for call warrants, and pick up the difference in the spread price, and also gain via the interest charge which equates with time value, but usually at a higher rate than options (generally warrants are dearer than options, but because they are an OTC (over the counter) instrument, the conditions can vary considerably depending on the type of warrant, and the terms of the issuer).

With put warrants the issuer may sell the underlying to hedge, but may only sell a proportion depending on the delta and the strike price.  Again this can vary widely depending on the warrant conditions, and how the “matrix” is configured.  The matrix essentially equates movements in the underlying with corresponding values in the warrant, and can be altered under certain conditions (these usually allow the issuer a lot of leeway – includes adjustments for dividends).

The issuer may also hedge in other markets, and the larger organisations probably have a cohesive strategy in several markets to hedge their positions, or take a net long or short exposure depending on their internal policy.  They may only partially hedge in some cases.  As you can imagine there are a range of possibilities, especially when a large OTC issuer may also deal in structured financial instruments, swaps, futures, bonds, options, Forex etc.

I hope that answers your question.


Regards,


Magdoran


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## GreatPig (16 November 2006)

And it seems they also hedge simply by not offering anything like true value at critical times... 

GP


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## Mofra (17 November 2006)

Magdoran said:
			
		

> I hope that answers your question.



Mag,

Yes it does to perhaps the best degree possible (without being an employee of a major warrant issuer!). Interesting that Warrant issuers would take a much wider view/strategy with respect to hedging their issues.

Cheers,

Mofra


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## Jake Hall (21 November 2006)

One tiny question about CFD's since it was mentioned here 


What's the difference between MM's and DMA when trading CFD's? I guess the shouldnt be any, since at the end we trade underlying security with bigger leverage rather than usual and if there isnt enough shares for certain price range - than noone could fill your order even MM... or the difference is with spread only?


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