MM questions

[markrmau]

1. Do all MM's have the same bid/ask spread for an option? ie, if I look up on commsec for bid/ask prices are these the best prices? Would I be better off with a different broker?

Are the MM's tied to the broker?

2. Does the MM look purely at the BS fair price option valuation, then work out thier bid/ask from this? Do they ever look at fundamentals or charts (or are they happy that this has all been allowed for in volatility etc)?

3. How were options valued before 1972 (Black Scholes)?

Thanks, Mark.
(slowly working my way there).

 

[SuperTed]

1. No ,

No depends if its a/ live price b/ how much volume..sometimes on the small low vol series a market maker will just sit there fishing both ends of the spread

Commsec seem ok as a starting point, my broker (not commsec) tells me who is in the que either side (ie if they are retail or a Market maker). A discount broker like commsec prob wont tell u that, so therefore you wont know how the game will be played if you either trying to enter or exiting the position ;-)

No, MMs are brokers (if thats what you mean) BASED on the ability to make trades. They dont need a broker to do this.

2. No..the words fair price and market makers shouldnt be used in the same sentence..hence if it only you and a market maker in the series then you will get shafted no matter what fair pricing model you use......(better to walk away or go to another series or stock).

The only thing that attempts to keep the price fair is volume. Very active series (normally close to or atm) will give a fairer price then something further away.

3. Dont know, whatever it was its redundant and doesnt matter ;-)

 

[markrmau]

Thanks for your response. I see that I better get a decent broker for this.

If I was thinking of a strategy where I would be buying options that are just out of the money with 1-2 month expiry, would this have a decent liquidity where I wouldn't be competing with only the MM?

Are there any prefered sources of historical data for backtesting? I am looking at www.boursedata.com.au

 

[DTM]

Thanks for your response. I see that I better get a decent broker for this.

If I was thinking of a strategy where I would be buying options that are just out of the money with 1-2 month expiry, would this have a decent liquidity where I wouldn't be competing with only the MM?

I think you have to stick to the most liquid stocks like BHP, the banks etc to get the liquidity you want.

 

[SuperTed]

Even liquid stocks can be a problem.

If you go to far away from the money even on liquid stocks it may be you and a market maker in that particular series. There is a bigger market closer to the money (naturally) and thus less a problem getting a fair price and getting filled.

Dont forget NWS ;-)

 

[RichKid]

I've been trying to see if market markers (for ETO's) are obliged to provide a sell quote if I make a bid, so far only found this which suggests they should be better than they are atm (see link below).

DTM or Mark mentioned in another post some time ago that if you call up comsec's options desk they are obliged to provide a quote but when I did they said they don't have a quote but just a theoretical price for that option. According to the ASX info below they should have a quote in 30secs. I wonder how it works?? Basically I think that when things look unfavourable they just kill the market, so even if it has got high open interest I find it hard to buy calls during low volatility.

......Hmmm, think I've figured it out, I think the condition relating to quote requests means that if there is a long dated option expiring more than 9mths from now I may not get a quote. So I assume very few mm's would choose to make a continuous market. I assume the quote requirement for series with less than 9mths is to account for effect of decay.

How market makers trade:

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.

This requirement is to ensure liquidity in the market, so that traders are more easily able to trade into and out of an option position.

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 two or more stocks in which they must meet certain obligations. 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 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 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% where the Market Maker has elected to make a market both on a continuous basis and in response to Quote Requests.

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.

PLEASE NOTE: There are NO Market Maker obligations in FLEX Classes.

Maximum spread and stock category 131KB (link)

How market makers trade (link)

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

 

[sails]

This link to the ASX site might help. http://www.asx.com.au/investor/pdf/notices/Clm15105.pdf. Scroll down to page 2 and about a third of the way down on that page you will see that all Aussie optionable shares are listed and details those that have continuous quotes, quote requests, etc. Also shows how the more liquid options have several market makers, whereas some may only have one MM for a quote request. As primarily an options trader, I go through this list from time to time to make sure the charts I watch are only those that have plenty of MM's competing with each other. Doesn't guarantee a good fill but the chances are somewhat improved!

 

[RichKid]

This link to the ASX site might help. http://www.asx.com.au/investor/pdf/notices/Clm15105.pdf. Scroll down to page 2 and about a third of the way down on that page you will see that all Aussie optionable shares are listed and details those that have continuous quotes, quote requests, etc. Also shows how the more liquid options have several market makers, whereas some may only have one MM for a quote request. As primarily an options trader, I go through this list from time to time to make sure the charts I watch are only those that have plenty of MM's competing with each other. Doesn't guarantee a good fill but the chances are somewhat improved!

Thanks very much Sails, that was very helpful, wish things were more liquid, I might have to look at CFD's sometime later. So much for my well laid plan, no instrument to execute it with! (Had my eye on going long PRK, a low risk trade imo (if there is one) so no mm wants to lose money). Might have to find some warrants but even less choice there.

 

[sails]

Thanks very much Sails, that was very helpful, wish things were more liquid, I might have to look at CFD's sometime later. So much for my well laid plan, no instrument to execute it with! (Had my eye on going long PRK, a low risk trade imo (if there is one) so no mm wants to lose money). Might have to find some warrants but even less choice there.

RichKid, I haven't traded warrants as yet, but when comparing to option pricing (identical strike and time to expiry) they seem to be very expensive. I think CFD's would be a good way to go for straight directional trading - eliminating the problems with time decay and risks of IV values falling out of long option premiums.

Yes, very frustrating to find a good entry and no suitable instrument with which to trade! I have been working on understanding the greeks, etc, for the last couple of years so I can just trade the opportunities that come up on the most liquid shares attempting to benefit a bit from time decay and a bit from direction. Still mostly in experimental stages, but feel it is slowly starting to come together.

 

[money tree]

it is a common misconception that warrants have better spreads.

compare:

XYZWMA - 25.5/27 $20 strike, 4:1
XYZ1F - 103/107 $20 strike

when taking the ratio into consideration, the real spread becomes:

25.5 x 4 = 102 (worse than at market ETO sell)
27 x 4 = 108 (worse than at market ETO buy)

= 102/108