# "Market Makers" questions



## hissho (31 October 2006)

hi
i'm very puzzled by the thing called "market makers" and would like to ask for some enlightenment. anyone here who used to work as a MM?

1) it's said that market makers are there to provide liquidity. is it correct? is providing liquidity their only job? 

2) are market makers allowed to make money? there's a big difference between "they are allowed to make money if an opportunity presents itself" and "they are trying to make money WHENEVER possible"...

3) how can i tell if a bid-offer spread is put there by the market makers or natually by different bidders and sellers? i mean it's easy to tell when you can't find bid-offer prices---you just call your broker and request a quote--that quote must come from a market maker; but when you see a spread with bid-offer prices and with a very small open interest, for example 5, how can you tell?

4) do market makers do trades with other market makers? Will a market maker be able to tell(using their proprietary software) if a trade comes from another market maker or a private trader?

any help would be greatly appreciated, 
hissho


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## professor_frink (31 October 2006)

answers in red mate.


			
				hissho said:
			
		

> hi
> i'm very puzzled by the thing called "market makers" and would like to ask for some enlightenment. anyone here who used to work as a MM?
> 
> 1) it's said that market makers are there to provide liquidity. is it correct? is providing liquidity their only job?
> ...


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## rhmt01 (31 October 2006)

although market makers have a licence to print money, they do have certain obligations depending on the security.

http://www.asx.com.au/investor/pdf/asx_options_bid_ask_spreads_and_categories.pdf

a short explaination on what market makers do is here

http://www.asx.com.au/investor/options/trading_information/market_makers.htm

however you should make sure that the market makers are fulfilling their obligations. I've had a few problems with market makers offering bad spreads, but I found a quick call to ASX Market Control on 1300 655 560 pointing out the dodgy spread gets the MM's **** kicked pretty quickly. (and reverting back to the 'allowable' spread)


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## spitrader1 (31 October 2006)

professor_frink said:
			
		

> answers in red mate.



pretty damn close professor. options market makers are there to make money and deal with retail and insto clients. Its a little different in the cash market!!


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## spitrader1 (31 October 2006)

spitrader1 said:
			
		

> pretty damn close professor. options market makers are there to make money and deal with retail and insto clients. Its a little different in the cash market!!



this may also help

https://www.aussiestockforums.com/forums/showthread.php?t=3980


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## professor_frink (31 October 2006)

spitrader1 said:
			
		

> pretty damn close professor. options market makers are there to make money and deal with retail and insto clients. Its a little different in the cash market!!



Better fill me in on which parts I was a little off on spi- I'll have my professor tag stripped from me by the international professor's association if I'm caught giving out dodgy advice


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## spitrader1 (31 October 2006)

professor_frink said:
			
		

> Better fill me in on which parts I was a little off on spi- I'll have my professor tag stripped from me by the international professor's association if I'm caught giving out dodgy advice



haha....you werent wrong on any...but i can provide clarification on one issue, of trading with each other. How else would they get access to liquidity when they want to Prop trade (they do this as well as performing there MM job)-----just a hint, most of the banks view the market making department as a way of getting there prop traders reduced ASX fees, not as a primary market making department.


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## professor_frink (31 October 2006)

spitrader1 said:
			
		

> haha....you werent wrong on any...



Phew... Can keep my title for now  


			
				spitrader1 said:
			
		

> but i can provide clarification on one issue, of trading with each other. How else would they get access to liquidity when they want to Prop trade (they do this as well as performing there MM job)-----just a hint, most of the banks view the market making department as a way of getting there prop traders reduced ASX fees, not as a primary market making department.



that doesn't surprise me at all.


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## hissho (31 October 2006)

Thanks Professor!

just a follow-up question: if MMs are there to make money and do it whenever possible, is there a chance that they could lose money? if they do have a chance of losing money, what could be the cause? maybe because of failing to hedge themselves successfully? but MMs are all perfectly hedged aren't they??...need some more enlightenment 

cheers
hissho


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## hissho (1 November 2006)

helloooo professor!

any more help please? I heard MMs all hedge themselves perfectly so i'm wondering how they hedge themselves. and if they are always properly hedged, how can they lose money?

thanks again!
hissho


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## professor_frink (1 November 2006)

hissho said:
			
		

> helloooo professor!
> 
> any more help please? I heard MMs all hedge themselves perfectly so i'm wondering how they hedge themselves. and if they are always properly hedged, how can they lose money?
> 
> ...



Sorry Hissho, completely missed your question-wasn't at the computer last night.
To be honest I couldn't tell you the answer to your question.
At a guess, I would have to say that it's possible for them to lose money-nobody's perfect after all.


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## spitrader1 (1 November 2006)

hissho said:
			
		

> Thanks Professor!
> 
> just a follow-up question: if MMs are there to make money and do it whenever possible, is there a chance that they could lose money? if they do have a chance of losing money, what could be the cause? maybe because of failing to hedge themselves successfully? but MMs are all perfectly hedged aren't they??...need some more enlightenment
> 
> ...



hissho, there is no such thing as a perfect hedge. even if a MM hedges there delta, they still have interest rate risk, divindend risk, volatility risk, without even getting into the second derivatives like gamma. Of course MM's can loose money. THats why only the good ones last. And dont forget, as ive already said, to most of the MM's, making markets is a secondary feature to there real role, which is derivative prop trading.


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## Magdoran (2 November 2006)

hissho said:
			
		

> hi
> i'm very puzzled by the thing called "market makers" and would like to ask for some enlightenment. anyone here who used to work as a MM?
> 
> 1) it's said that market makers are there to provide liquidity. is it correct? is providing liquidity their only job?
> ...



Hello hissho,


In addition to the comments made on this thread, I’ll try to offer some additional information for you to consider.

Think about how an options market works.  For a transaction to happen, two parties must take opposite sides of the contract for a trade to occur (we all know the basic definitions for calls and puts, don’t we?).

*Liquidity in Options Markets:*

How is this achieved?  In order to ensure liquidity, exchanges grant market making licenses to trading organisations which fulfil certain requirements to be appointed, and carries a range of obligations contractually with the exchange.

This requirement varies between exchanges, but essentially requires a market maker to maintain a bid and an ask of a certain size (amount of available contracts) within a range of strikes from the current price, and with restrictions on how wide the spread can be from the bid to the ask.

*How do MM’s Hedge?*

So, how do market maker’s hedge?  When you buy a call from a market maker, the market maker may hedge by buying some stock in the market.  How much stock they buy will depend on their risk policies.  If you buy an ATM (at the money) call, they may only buy around 500 units of stock (assuming Australian 1000 shares per contract) since the delta will probably be around 50% (the option will move 5 cents to a 10 cent move in the underlying).

If you bought an OTM (out of the money) call with a 30% delta, they may only buy 300 units of stock to hedge for example.  But as spitrader1 points out they are still at risk with interest rates and volatility shifts, but they can hedge these two in a number of ways using structured financial products, futures, bonds, etc.

The way market makers deal with dividends is generally to adjust the volatility levels, reducing the volatility of call values incrementally as they near exdiv (and resetting post exdiv to normal), and increasing the volatility proportionally as they near exdiv (again resetting post exdiv).

On any given trading day, a good market maker usually has an algorithm set up to take into account the entire aggregated effect of long calls, short calls, long puts, short puts, and long/short stock they are holding, at different strike levels and different expiry times.  They can adjust the theoretical exposure to be as nearly hedged as possible, or can adopt a policy direction if they have a market view and be skewed either long or short the stock based on the configuration of the overall positions.

Think about how a bookie works when taking bets on two football teams.  They may offer $8 return to a $10 bet to win in a 50/50 game.  They are hedged if one person bets these odds on team A, and another person bets on team “B”.  They take $2 profit, and can’t lose.  They pay the winner their original $10 back, plus the $8 win, and keep the $10 form the loser, making $2 profit.  This is how market makers with options aim to profit from the bid and ask spread.  

Of course giving odds in a horse race is more complex, and a little more like the options market.  If someone buys 10 ATM put contracts, and you buy 10 ATM call contracts, of the same stock at the same time, these can essentially reduce the risks as the stock moves. 

Think about how bookies work at the racetrack by offering odds.  Market makers work in a similar way to make money, generally by pushing the buy price higher than fair value based on the current price of the underlying, and the current volatility levels, and the same for the sell price – pushing it lower.

Different market makers can be making a market for the same options series, and you can find one is offering the bid, and the other is offering the ask, with each others other side being further out than the other.  This effectively reduces the spread when it happens.  A lot depends on how aggressive a market maker is, and what kind of policy they adopt in terms of exposure.

It is entirely possible for one market maker to trade with another (just like a bookie does) to hedge risk.  Think about a bookie that takes two bets on a 100-1 odd horse.  They may make one bet with another bookie to reduce their exposure.  The same is true for Market makers.  They may transact with anyone in order to hedge a position.  It is more likely that they will look to do this using shares though.

The market maker’s aim is to make as much margin on each transaction as possible– if you are offering a trade which hedges another trade on the opposite side, you may get set around fair value or better, especially if there is a lot of activity on the other side of the market (i.e you’re entering bullishly while the majority are taking bearish action).  But if you’re exiting on stop, and they see you coming, they may widen the spread, or skew it as people get shaken out of positions.  This is partly how they can maximise their profits.

Another thing to think about is that in less liquid stocks, your transaction size will be based on the availability of stock.  For instance, if buying puts, the market maker will try to sell a corresponding amount of stocks in the market, hence they will be looking at the available shares on the bid to hedge, depending on the expiry date and where the strike is (ITM, ATM, OTM).  

So, if you’re looking to buy 10 ATM put contracts, and only 2500 shares are available on the bid, they may only transact 5 contracts at that point, if the theoretical margin is sufficient.  If not they may not transact with you at all.  Just keep this in mind when you get a partial fill.  

The availability of shares to hedge the opposite side may be a determining factor of where you will get set if there isn’t any activity in other options.  Also, if others are looking to take a similar position to yours, but at a different strike, this may reduce the available shares to hedge too.  The more players, the more difficult it is for you to monitor.  Hence you can get set at some amazing prices if you work out the plays for the whole range of options and stock…

I hope that gives you all food for thought!


Regards


Magdoran

P.S. Margaret, this may illustrate some of my thinking about how to play the market makers that you have been asking me… hope it helps.  Mag


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## Bobby (3 November 2006)

Magdoran said:
			
		

> But if you’re exiting on stop, and they see you coming, they may widen the spread, or skew it as people get shaken out of positions.  This is partly how they can maximise their profits.
> 
> 
> Magdoran your whole post was very good !
> ...


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## Magdoran (3 November 2006)

Bobby said:
			
		

> Magdoran said:
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## wayneL (3 November 2006)

Just like to add, from my understanding, the most common MM hedges (in the options markets) are the conversion and the reversal; locking in an arbitrage profit.

That's not to say they won't take on some risk via the combos' that Mag mentioned, or indeed other spreads ('flys etc), but that is the most common


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## Magdoran (3 November 2006)

Magdoran said:
			
		

> The way market makers deal with dividends is generally to adjust the volatility levels, reducing the volatility of call values incrementally as they near exdiv (and resetting post exdiv to normal), and increasing the volatility proportionally as they near exdiv (again resetting post exdiv).



*Errata*

This comment should have read:

“and increasing the volatility proportionally *of puts * as they near exdiv (again resetting post exdiv).”

*Additional comments about the Australian Options Market:*

Also, a point I neglected to address is what market makers see.  My broker used to be able to tell me who was in the bid and ask, and I could know if it was a market maker like Timberhill, Optiva, Susquehanna etc, or a retail broker (and which broker), and the size of their order.

For some reason this was withdrawn, so I can’t do this anymore (really hate that – it’s like flying blind now).  So I’m not sure if the market makers can still see who’s order is in the system.  I suspect that they still can, but I don’t know (anyone???).  But they have a very good idea about who’d playing in the market, and in part they can tell a lot about how you handle your order.

If you jiggle your order up and down, they’ll smell an amateur if their operator is awake, and they may play spread games with you widening the spread, enticing you to enter at a less favourable level, even if the underlying does nothing at all.  Beware of this, this is a standard market maker trick.  I found you really have to have an approach in mind (almost a preconceived tactic) based on your view of the underlying and what it will do.

A lot depends on the strategy you are entering/exiting, and the time frame you have in mind, and the level of profit you are looking for.  If you’re scalping, this is radically different to position trading.  I’m a position trader, so my style is not suitable for a scalper/intra-day trader. 

*Tactics:*

Ok, I’ll make some general comments about a directional style, with a focus on basic options positions positions.  Spreads can require some other angles such as skews etc, but I won’t focus on this here.

Basically the idea is to know in advance which tactic to employ for the situation ahead of time.  Also, it’s like being a boxer in training – you have to study and perfect your moves.  Develop your own style, and keep your flexibility up (mental in this case), and psychology in good shape too.  I’ll just outline the basics, but be aware that there are many facets to this, and that these examples are at the basic level.  There is much more to this. 

Tactics:  (a) You can just take the bid or ask decisively if you think the value is good, and you’re expecting a significant move, so just pay up and be done with it, follow your entry rules. (b) Enter just over the middle of the spread.  (c) Enter an order at the level you think will be just inside the best price for the day based on your projections and leave it – especially if your position can be entered over a couple of days time, and you can pay up a bit later.

Generally if you’re expecting a move that day, just get set.  If you think you have time to get a good price, try to enter on a suitable day.  If going long an option like buying a call for instance, look for the underlying to mark time for a couple of days looking for volatility to drop a few points, then enter later with less theta decay.  If you see a reversal day (depending on the whole pattern), it may pay to wait a couple of days for the volatility to abate, since market makers often inflate the price on obvious pivots.

If you’re selling, you want to sell when the premium is high in terms of volatility usually in the opposite direction to where you think the underlying is going to go.  You want to sell on a volatile day.  Hence you have to time it right to maximise the premium.  Best time is to sell into a frenzy when the demand is high.  As you can imagine there is an art to this. (By the way, I don’t sell naked – this is highly risky, up to you if you have sufficient funds or stock etc – I tend to use spreads to cap the risk – it’s a personal choice though).

If you think the underlying is turning hard and quickly, sometimes it pays to just be decisive and get in (or out).  You have to be the judge of this…

Think about it this way.  The “slippage” is a cost of doing business.  The market makers provide a necessary service in ensuring liquidity, and they have to make a living.  You have to pay the piper.  If they don’t get to eat, there couldn’t be an options market.  So don’t begrudge them a reasonable bite.  Do avoid over paying them, unless it is to your benefit.  Only pay up or accept a lower price when necessary, either to secure a significant move, or to avoid a significant loss, or to secure the lion's share of a profitable trade.  This is where experience is important.


Regards


Magdoran


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## Bobby (3 November 2006)

Magdoran said:
			
		

> Bobby said:
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## wayneL (3 November 2006)

H.G. Wells said:
			
		

> If you jiggle your order up and down, they’ll smell an amateur if their operator is awake, and they may play spread games with you widening the spread, enticing you to enter at a less favourable level, even if the underlying does nothing at all. Beware of this, this is a standard market maker trick. I found you really have to have an approach in mind (almost a preconceived tactic) based on your view of the underlying and what it will do.




Haha yes! MM games are legendary stuff; good for hours of amusement if you know how they think. Cat & Mouse!

The fun part is in deciding who is the cat and who is the mouse. LOL


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## Bobby (3 November 2006)

wayneL said:
			
		

> Haha yes! MM games are legendary stuff; good for hours of amusement if you know how they think. Cat & Mouse!
> 
> The fun part is in deciding who is the cat and who is the mouse. LOL



 This intrigues me, wonder if there is a pendulous strategy to play the mouse in disguise ?


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## Magdoran (3 November 2006)

@#$%&*!!!

Market makers (said in the voice of Marvin the terminally depressed robot off "The Hitchhiker's guide to the Galaxy"), don’t talk to me about market makers…

The #$%$#rds!  Dropped my volatility in my formerly way OTM now nicely ITM options by over HALF!

I don’t have a problem with them making a cut, but 25% give or take of the theoretical value based on the low end of the volatility spectrum is just robbery.


Thinking what I can do, but selling in a different strike with such low volatility makes no sense.  Think I’ll hold and let intrinsic value do the work…


Mag


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## sails (3 November 2006)

Mag, would it work to roll up a strike (or more) to lock in some profit now that you are ITM and IV so low?  Will probably depend how far out you are in time.

Is this a post earnings announcement where IV has collapsed?

Margaret.

PS - I've skimmed through your posts on this thread, but will go through more thoroughly when I get time and post some comments then!


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## wayneL (3 November 2006)

Magdoran said:
			
		

> @#$%&*!!!
> 
> Market makers (said in the voice of Marvin the terminally depressed robot off "The Hitchhiker's guide to the Galaxy"), don’t talk to me about market makers…
> 
> ...



*empathetic chuckle*


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## Magdoran (3 November 2006)

sails said:
			
		

> Mag, would it work to roll up a strike (or more) to lock in some profit now that you are ITM and IV so low?  Will probably depend how far out you are in time.
> 
> Is this a post earnings announcement where IV has collapsed?
> 
> ...





Hello Margaret,


Spot on, post earnings volatility crush down to 0.  I bought around the 10-11% range…

This is the problem with straight calls as opposed to puts.  As the underlying goes up, the volatility can fall quickly if there is lots of selling pressure in the option you’re in on a strong up day.  Going down, the volatility can swing up quickly, so straight bearish plays tend to beat straight bullish plays in my experience.

It’s just that I’ve never experienced such a strong downturn in the volatility, but hey, I was holding a winner, so the MM’s got a good feast today.

Ended up exiting half to lock in the profit, but have a time target for later this month.  Bought with plenty of time before expiry for all my current positions.

I couldn’t think of a good morph or a reasonable play with the skew, looked at the options slightly above and below and one time frame ahead and behind… I couldn’t find anything that looked better than just taking half out on strength as the underlying made a new high towards close, and it had hit my exit half price target and was well and truly over the double…

Were you suggesting selling out, and moving up a strike and buying that – or changing months?  The volatility was skewed so that the further out of the money you went, the higher the volatility got, and the next month out didn’t look much better.  The problem was if you sold one of these, the volatility could swing back up once you’d sold it, and I am only expecting a limited pull back…

This is a real quandary as to how to handle this differently… I haven’t encountered a magnitude like this before.  I wouldn’t mind some movement, but this amount was the most I’ve ever experienced…

Have you experienced this level of crush before?


Regards


Magdoran


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## Magdoran (3 November 2006)

wayneL said:
			
		

> *empathetic chuckle*




Thanks Wayne, I know this kind of stuff happens in the US market, but this is Australia damn it!  We’re supposed to be more civilised! Hahaha…


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## Magdoran (3 November 2006)

Bobby said:
			
		

> Magdoran said:
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## sails (3 November 2006)

Magdoran said:
			
		

> Hello Margaret,
> 
> 
> Spot on, post earnings volatility crush down to 0.  I bought around the 10-11% range…
> ...



Hi Mag,

Yes, I remember one particular time when the underlying had been going sideways prior to an earnings announcement.  I had been looking at a strangle, however due to high IV, decided to wait until after the announcement to see if it could be purchased at a cheaper price.  The crush was amazing - watched it happen before my eyes -  ended up being about a 50% reduction in the option price and not unlike watching the air fizzing out of balloon.  

I was suggesting rolling up vertically (selling and buying higher) - obviously would depend on how much credit you could take in vs. closing out half as you have done and whether a vertical skew could have been an advantage.  If there are fast moves to come, rolling up retains the original quanitity and will do better than the half quantity at a lower strike. So many trade-offs in options!

Agree that it is always more difficult with straight long calls due to the fact that IV often does decrease as the underlying climbs.  It takes a really fast move for gamma to outrun theta and falling IV on the upside.

Anyway,  well done on a winning trade!

Margaret.


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## hissho (4 November 2006)

Hi Mag
after reading your posts i've got some more questions:

1) for those very liquid stocks(like top 20), are the bid/ask spread set by market makers or actually by hundreds of thousands of traders?

2) (following question 1) do market makers intervene and set bid/ask spread *ONLY* when the stock is not liquid enough?

3) on a very liquid stock, the bid/ask spread tend to be very narrow which means more efficiency. in this case, how can market makers widen the spread and squeeze you?

4) i keep hearing bad experiences with market makers such as they rip you off etc. but after doing some homework i found that "market makers are not something you want to beat; they are there to provide liquidity and thus making the market more efficient, not to rip you off"... what do you reckon? should i change my mindset from "it's our enemy; i should beat the bastard" to "they are just doing their jobs"?

any comments would be much appreciated,
hissho


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## Mofra (5 November 2006)

hissho said:
			
		

> 4) i keep hearing bad experiences with market makers such as they rip you off etc. but after doing some homework i found that "market makers are not something you want to beat; they are there to provide liquidity and thus making the market more efficient, not to rip you off"... what do you reckon? should i change my mindset from "it's our enemy; i should beat the bastard" to "they are just doing their jobs"?



Hissho,

How you view MMs will definately depend on how you chose to trade. For ST traders taking single leg positions (long calls & puts, trading pure direction) then then the slippage between bids/asks is likely to have a dramatic effect on your end of month results, as a function of your trading volume.

I tend to focus more on written spreads where I can be a little more patient (unless one leg is filled & the other is left open - not fun at 3.45pm!) and I tend to write 1c slippage on each leg into my entry plan - not ideal profit wise but if my entry parameters have been met & I am comfortable with my position, I will pull the trigger.

As much as every trader will slag off those "devious MMs" a number of times in a day/month/year (depending on your style of trading), this is probably going to be comparable to the number of complaints about the lack of liquidity on a series you would otherwise have traded - and MMs do provide liquidity as a function of their role.

Cheers,

Mofra


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## happytrader (5 November 2006)

Hi all

I used to get quite annoyed with the antics of market makers until I realised that it didn't make much difference to my bottom line.

Try not to hold a grudge, otherwise it could find expression in another trade. Forgive and forget and don't get too distracted by what the other half is doing.

Cheers
Happytrader


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## sails (5 November 2006)

Here is a link to the latest free options trader magazine http://www.optionstradermag.com/kety59/OptionsTrader1106.pdf which has an article on MM's


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## Magdoran (5 November 2006)

sails said:
			
		

> Hi Mag,
> 
> Yes, I remember one particular time when the underlying had been going sideways prior to an earnings announcement.  I had been looking at a strangle, however due to high IV, decided to wait until after the announcement to see if it could be purchased at a cheaper price.  The crush was amazing - watched it happen before my eyes -  ended up being about a 50% reduction in the option price and not unlike watching the air fizzing out of balloon.
> 
> ...



Hello Margaret,


Thanks…

Interesting concept of rolling the strike up – I thought about that, but had very limited time to make a decision, and figured I’d exit half, and look to re-enter, and even add to the position if the price action warrants it.  I have a really good time cycle running at the moment, it doesn’t get much better than this. But there is a possibility that there may be a correction, and taking profits like this means that I have a guaranteed profit even if the second half moves to 0 (although I don’t intend to let this happen).

Also, trying to sell with such volatility just didn’t make sense, although the puts are much higher than the calls, around the 25% range, so perhaps selling puts may be an option here too, but the profit level is capped…  I also considered a ratio back spread approach, but didn’t like the risk to reward parameters…

Something to ponder for the next time this happens…

Thanks for your perspectives!


Regards


Magdoran


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## wayneL (5 November 2006)

H. G. Wells said:
			
		

> although the puts are much higher than the calls, around the 25% range,




Is there a div. involved? Why not arb it?


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## sails (5 November 2006)

Magdoran said:
			
		

> ...Also, trying to sell with such volatility just didn’t make sense, although the puts are much higher than the calls, around the 25% range, so perhaps selling puts may be an option here too, but the profit level is capped…



That's quite a difference in IV between the puts and calls...
Could it possibly be due to a dividend being factored into the puts rather than IV?

LOL - must have hit send at the same time, Wayne!


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## Magdoran (5 November 2006)

hissho said:
			
		

> Hi Mag
> after reading your posts i've got some more questions:
> 
> 1) for those very liquid stocks(like top 20), are the bid/ask spread set by market makers or actually by hundreds of thousands of traders?
> ...




Hello hissho,


Here are some answers to your questions:




			
				hissho said:
			
		

> 1) for those very liquid stocks(like top 20), are the bid/ask spread set by market makers or actually by hundreds of thousands of traders?




The Bid and the Ask can be comprised of either a market maker’s or a non-market maker’s order, or both, at any given time.  The thing to realise is that there are certain rules the market makers are obliged to follow. 

But even in realatively illiquid flex designated stocks, you can at times have natural liquidity that are driven by non-market makers, but this density of this activity varies depending on each situation.  Sure, on average the very liquid stocks tend to have more interest, hence more non-market maker orders in the system at various times.

So, if there is a lot of action in a specific option strike, you can have very tight spreads at times with many different players buying and selling in a “hot” period of activity.



			
				hissho said:
			
		

> 2) (following question 1) do market makers intervene and set bid/ask spread *ONLY* when the stock is not liquid enough?




This depends on their obligations.  In flex options, they may not interact at all if they don’t want to, but in markets that they have an obligation to make a market, they certainly can interact just like any other person or organisation can to buy or sell at a price. 

Any buy order below the buy price of the bid, or any sell order above the sell price of the ask is unlikely to transact unless a big order sweeps all the existing orders out and is at the same level or deeper…

But sure, if there is a natural market in play, they may not transact at all, but still may have a bid and an offer, but it may be behind other orders. Certainly if it is not in their interest to do so.

Don’t forget, to make money they try to obtain a margin or gain some arbitrage or other benefit from the transaction one way or another.  You may not know their strategy since they can operate on several different levels and in different markets you may not be aware of.  As you can imagine this depends on a lot of variables, such as the market we are talking about, which particular organisation, and the current policy or strategy in place.



			
				hissho said:
			
		

> 3) on a very liquid stock, the bid/ask spread tend to be very narrow which means more efficiency. in this case, how can market makers widen the spread and squeeze you?




In this case, they are probably more reliant on volume as opposed to widening the spread if there are a lot of orders in play in a “hot” market, hence you tend to be able to get narrower spreads.  

What is often misunderstood though, is that it is not only the width of the spread that is important, but where the spread is located in relation to the current price of the underlying.  The MM’s can actually keep the spread range the same, but move the centre of this spread up or down depending on the objective of the market maker.  

If they think a lot of players are going to exit long calls for instance on a significant move up, they may drop the volatility and move the spread down…

If they think a lot of players are going to exit long calls for instance on a significant move Down, they may drop the volatility and move the spread down too…

If they think a lot of players are going to buy a strike, they may inflate the price, and move the centre of the spread up (move the volatility up).

Just try to think what you’d do in any market situation to maximise your margin as a market maker, and you’ll get the idea.



			
				hissho said:
			
		

> 4) i keep hearing bad experiences with market makers such as they rip you off etc. but after doing some homework i found that "market makers are not something you want to beat; they are there to provide liquidity and thus making the market more efficient, not to rip you off"... what do you reckon? should i change my mindset from "it's our enemy; i should beat the bastard" to "they are just doing their jobs"?




As I said earlier, without market makers, you would have a very poor options market, and this could severely limit liquidity.  I fully agree with Mofra’s viewpoint here.  It is a trade off, having to pay slippage is as I said earlier a cost of doing business.

This is especially true if you are looking at long calls or puts with directional trades.  As Mofra points out, there are strategies to combat this using spreads, but these also have trades offs like capped profits, and extra brokerage to be considered.  A lot will depend on your trading style, and preferred approach.  Volatility is also an aspect to be considered.  Spreads can suffer from low volatility (especially when selling), as much as straight calls and puts can suffer from high volatility and volatility crush.

If you read my earlier comments I was not happy with a recent volatility crush, but at the same time I fully understand what the market maker is doing, and while I don’t like it because I’d prefer to have the profit in my pocket, I fully understand that they have every right to maximise their profits as any of us have, and on that level acknowledge it when they win a round.  They are maximising their profit in a game that is clearly stated in the exchange rules.

In my view, carveat emptor.  If you’re going to play in the options market, it is up to you to do the due diligence to understand the risks, and make market decisions accordingly. They provide a service, but do so at a price.  They both have to make a living, and like us, want to maximise profits.  That is the way of the market.

As happytrader quite wisely says, “try not to hold a grudge” or “get too distracted by what the other half is doing”.  Couldn’t agree more.  Take the emotion out of the process, and focus on what is going on, and success is more likely to find you!


Regards



Magdoran


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## Magdoran (5 November 2006)

wayneL said:
			
		

> Is there a div. involved? Why not arb it?







			
				sails said:
			
		

> That's quite a difference in IV between the puts and calls...
> Could it possibly be due to a dividend being factored into the puts rather than IV?
> 
> LOL - must have hit send at the same time, Wayne!




Hi Guys,


There is no dividend that I'm aware of that is current, and the puts have diverged from the calls for quite some time now - calls around 9%, puts around 26%.

What kind of arbitrage did you have in mind Wayne?


Magdoran


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## wayneL (5 November 2006)

Mag,

I was thinking of a reversal, but commish would probably eat all the profit here in OZ.

Cancel that Idea


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## Jake Hall (21 November 2006)

Dear Sir's and Madams', I'm sorry for upping this thread again, just googled this very interesting forum and since I'm interested in AU stock market, your advises would be very important.

Could anyone please help me with following questions regarding options trading?

1. At ASX website I mentioned some notices like "Continuous markets

Market Makers who choose to make a market on a continuous basis are obligated to provide Orders continuously for certain percentages of time* in eighteen series per Underlying Security, encompassing three calls and three puts in any three of the next six expiry months. The criteria is based on the previous Trading Day's closing price of the Underlying Security and is selected from:
1. Those Series at-the-money

2. The next three in-the-money

3. The next three out-of-the-money

Each Order being for at least the Minimum Quantity and at or within the Maximum Spread requirements"

Q: Does this mean that MM's choose ALL 3 series to make market that follow ATM series? For instance current spot price is 30, strikes go every dollar like 26,27,28 etc(lets assume we're studying calls). What will be the MM's range of activity in this case?
27,28,29(ITM), 30(ATM), 31,32,33(OTM)? Or just 30(ATM) and 2 random series like 27+33,  28+31 ?


Question number 2 

Basing on above mentioned data, what happens if market jumps suddenly for 2-3 strike prices up or down(for instance because of reporting unusual success from underlying security company)? What should ordinary customers do in this case since MM's wont be supporting current options classes range and the lack of liquidity arises? Just sit back and wait for the market go back? This refers to when there are continues MM's.

Thank you in advance.


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## Jake Hall (26 November 2006)

Guys come on, I'm sure you know the answers    :   Please take a minute to advise me.

Sincerely, Jake Hall.


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## Magdoran (4 December 2006)

Jake Hall said:
			
		

> Dear Sir's and Madams', I'm sorry for upping this thread again, just googled this very interesting forum and since I'm interested in AU stock market, your advises would be very important.
> 
> Could anyone please help me with following questions regarding options trading?
> 
> ...




Jake,


I would suggest that you continue to access the ASX website for current rules and conditions:

http://www.asx.com.au/

This and other relevant information is freely available from the ASX site.  Please note that this kind of detail can change, and that there are a range of relevant PDF’s available on the site, you really don’t need to consult the ASF boards for this information if you do your own research.

On this occasion I’ll do your research for you, and also outline some aspects that are also relevant to consider.

Firstly note that there are optionable stocks with market maker obligations, and then there are “flex” options which do not carry market maker obligations.

Focusing on the options which do carry market maker obligations, these are divided into 2 categories (1 and 2) depending on their liquidity which effects the maximum width of the spread allowed (see http://www.asx.com.au/investor/options/trading_information/market_makers.htm and access the two documents “maximum spread widths”, and “How market makers trade”.)





> *Quotes from the ASX on your question* – this can be accessed by the link below:
> 
> 
> http://www.asx.com.au/investor/options/trading_information/market_makers.htm#Maximum spreads
> ...



So, if a stock jumps up or down, the ranges of markets required may not be centred at the money, but in relation to the previous days close.  Many market makers though may extend the range of options covered depending on the liquidity of the underlying, and on their internal strategy/policy, but are not required to.

Hope that helps Jake.


Regards,


Magdoran


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## Flathead Flick (17 December 2006)

Wow, great thread - lots of good info here. 

It's been mentioned that people slag off MMs every now and then, and I've got to say, I'm one of them. After getting scewed (I won't name names) on quite a few trades I pulled up stumps and moved to a DMA provider. No problems ever since, be with with my trades or even liquidity. I've since spoken to a former employee from the provider I used to use and he mentioned that the firm ACTIVELY tries to manipulate trades so that they come out on top. Now, I've got to put a caveat on this - the employee is a disgruntled former employee, and while I trust what he says, it does need to be taken with a grain of salt. Sure, the company is trying to make money, just as we are, but I don't like the idea that the company has so much control over the price they 'decide' to give me...

While I have been trading CFDs for a little while, I'm by no means an expert so my trading strategies are far from fancy. For my level and for other beginner CFD traders, I reckon you can't go past DMA providers for the simplicity and transparency. 

Magdoran - or anyone else - do you have any ideas on pros and cons for CFD providers depending on length of time trading, different trading strategies, etc.?


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## Magdoran (17 December 2006)

Flathead Flick said:
			
		

> Wow, great thread - lots of good info here.
> 
> It's been mentioned that people slag off MMs every now and then, and I've got to say, I'm one of them. After getting scewed (I won't name names) on quite a few trades I pulled up stumps and moved to a DMA provider. No problems ever since, be with with my trades or even liquidity. I've since spoken to a former employee from the provider I used to use and he mentioned that the firm ACTIVELY tries to manipulate trades so that they come out on top. Now, I've got to put a caveat on this - the employee is a disgruntled former employee, and while I trust what he says, it does need to be taken with a grain of salt. Sure, the company is trying to make money, just as we are, but I don't like the idea that the company has so much control over the price they 'decide' to give me...
> 
> ...



Hello Flathead Flick,


Have a look at my comments on “The idiots way to options riches” thread Post 12 regarding the comparison of CFDs and options to get a handle on my viewpoint.  Since I don’t trade CFDs my knowledge is theoretical, and formed from observation and conversations, hence I can only comment with limited authority without direct personal experience trading them.

Please understand that I have made a personal decision not to trade CFDs based on my estimation of the instrument, hence please be aware that I have reservations about using CFDs, and that my comments stem from this bias (and I recognise there are alternative viewpoints others have on this subject). 

Some people I know prefer CFDs, and trade them successfully for instance, but the successful players I know are very experienced, and have developed sophisticated analysis and systems approaches.

The reasons why I have not traded them is in part because of the risks associated with trading CFDs.  Here are some notable aspects: 

•	Credit risk if the provider becomes illiquid for one reason or another, 
•	Potential for Spread manipulation
•	Costs for risk mitigation (Guaranteed Stop Loss – GSL)
•	Risk to Reward ratio
•	Disclosure of stop loss to the opposing party

As for the DMA model, I haven’t had a chance to look at this in detail, and I wonder how this is achieved, and how the provider can guarantee that they will honour this approach. The problem is how do we know that they are actually delivering the result?  Who polices their actions, and how can we be sure that breeches will be reported, and some sanction applied? It sounds preferable to the previous CFD approach if it is real, and there is an unbiased party which can ensure that the provider delivers this kind of liquidity.

Generally though, if you’re T/A or trading style and system is any good, the relative slippage will really be a cost of doing business, provided your account is big enough to support the size of your positions.  As you can imagine there are a range of variables each person has to take into account when evaluating which instrument to trade.  This is true of dealing (or not dealing) with CFDs.


Hope that answers your question FF.


Regards


Magdoran


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## robots (17 December 2006)

hello,

with a cfd with either MM or DMA you are not buying/owning the shares, they will talk about all sorts of smoke and mirrors stuff 

cfd=contract for difference

when I was using IG Index for spread betting the SPI, the fluctuations in "their" price were enormous

around opening and closing their price would move erractically

I believe this is to stop you out and make you re-enter

I would have around 200 pt stops to counter this

thankyou
robots


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