"Market Makers" questions

[Magdoran]

@#$%&*!!!

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

 

[sails]

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!

 

[wayneL]

@#$%&*!!!

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

*empathetic chuckle*

 

[Magdoran]

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!

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

 

[Magdoran]

*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…

 

[Magdoran]

Gee Mag , the MMs must just love the dopes that set stops.

Yes Knowlegde is power ,.

I remember Henry Kissinger's womanizing , although Henry physical looks were at best crook, he did have a knack of pulling young pretty females who loved his Power above his looks.

Regards
Bob.

Indeed, Bobby,

Such were the decadent days under the auspices of “Tricky Dickie”!


Mag

 

[sails]

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

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.

 

[hissho]

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

 

[Mofra]

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

 

[happytrader]

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

 

[sails]

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

 

[Magdoran]

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.

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

 

[wayneL]

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

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

 

[sails]

...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!

 

[Magdoran]

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

Hello hissho,


Here are some answers to your 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?

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.

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.

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.

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

 

[Magdoran]

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

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

 

[wayneL]

Mag,

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

Cancel that Idea

 

[Jake Hall]

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.

 

[Jake Hall]

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

Sincerely, Jake Hall.

 

[Magdoran]

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.

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

Role of market makers

Market makers play an important role in the options market. Under ASX Market Rules they are required to provide quotes in certain option Series for certain percentages of time* .

This requirement is to assist in the price discovery process, so that traders and investors are more easily able to price and value an option position. Liquidity is assisted when there are multiple Market Makers in a class, however , as Market Makers are not required to provide quotes in all series or at all times there can be no guarantee that all series will have prices displayed .

Market makers compete against one another while trading on their own account and at their own risk. They can be either individuals or firms.

Each market maker is assigned one or more stocks in which they must meet certain obligations for certain percentages of time*. This involves quoting buy and sell prices for a certain number of series, and/or responding to requests from other market participants for prices.

Market Makers can choose to have the following obligations:
a) make a market on a continuous basis only; or
b) make a market in response to Quote Requests only; or
c) make a market both on a continuous basis and in response to quote requests.
The obligations of market makers are as follows:

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.

Quote requests

Market makers who choose to make a market in response to Quote Requests must provide orders on request for certain percentages of the time* for all Series up to nine months maturity in a Class for the Minimum Quantity and at the Maximum Spread.

The maximum elapsed time before responding to a Quote Request or replacing Continuous Orders is 30 seconds.

The minimum duration of an order is 30 seconds. An order can be amended on condition that the Minimum Quantity and the Maximum Spread is maintained.

* The required percentage for meeting Quote Requests only is 60%, and 50% of the Relevant Period where the Market Maker has elected to make a market both on a continuous basis and in response to Quote Requests. The Relevant Period is between 10.20am to 1.00pm and between 2.00pm and 4.00pm on each Trading Day.

Maximum spreads

Each security over which exchange traded options are traded has a category designated by ASX. The category is allocated by reference to the liquidity of the security.
The category of the security determines:
• the maximum spread (the difference between the bid and offer prices) the designated market maker(s) may quote when making a market
• the minimum number of contracts for which the market maker must quote a price. The minimum volume requirement is ten contracts for Category 1 Classes and five contracts for Category 2 Classes**.
** In respect to Maximum Spreads for Category 2 Classes, for obligation on a continuous basis, these are to be made to the satisfaction of ASX only on a best endeavours basis.
Please note: There are no market maker obligations in FLEX Classes.

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