The perils of legging a bull call spread: myth or fact?

[sails]

Thanks Sails for you MM insights.

On a MM related topic, I experienced something fishy yesterday which I'm trying to explain. There was a BHP OTM option with no quotes. Using TWS, I submitted an Request For Quote (RFQ) and the MM responded with the obligatory 30 second quote ie. bid/ask spread.

I also had the MD displayed for that OTM option as well. When the MM responded to my RFQ, the MD showed a queue, NOT 1 but 3 quotes deep. After the 30 second period, all 3 quotes in the MD disappeared simultaneously.

Why does the MM bother putting 3 quotes in the MD instead of 1? Although unlikely, is it possible that there are 3 MMs competing for BHP option trades? And all 3 competing MMs are somehow required to responded to RFQs for 30 seconds?

Hey Fox - you're welcome - but please remember any insights from me are mostly from careful observation and attempting to put the pieces together.

When I first started, the ASX used to put out a monthly PDF with all sorts of option related info. It also contained the list of MMs that were quoting on each optionable stock. It stated which ones were continuous quotes and which ones were by quote request only. Most of the optionable stocks hardly had any MMs - many of them only had one MM which quoted only on request. This list was helpful as I decided to remain with mainly BHP and the big four due to them being the best for MM liquidity at that time.

BHP was at the top of the list with the most MMs and, if memory serves me right, I think it was around 10-12 MM firms and the majority were on continuous quotes. I thought that meant there would be some competition between them, but methinks they must have some sort of an arrangement - maybe they take a half hour each (entirely my imagination - no fact basis!). But it is strange that they don't seem to be concerned about competition with another MM firm. I don't know why they operate so differently to US MMs who seem keen to snap up your order (within reason, of course).

Now, when they are on "continuous" quoting - that usually only means obligation for a certain number of strikes around the stock price and how far out in time is also a limited obligation. That would explain why no quotes for your FOTMs. Also, I believe "continuous" only means for a certain percentage of the day. Same with "quote requests" - they are only obligated to respond to a certain percentage - so if others have been requesting quotes, there is no guarantee your request will get a response.

A broker once explainted that MMs quotes are handled automatically. When we put in a quote request, we simply see what has been invisible - albeit for a 30 second window of opportunity.

So, when you get a few levels of MD for that tiny 30 second window, I would think it's because of the different MM firms that are running automated quotes. In the past when I have requested quotes for less liquid optionable stocks, it is quite common to only get one line - sometimes there's no response at all.

One little trick with that 30sec window of opportunity is to take a screen shot - that way you can take the time to digest it properly - work out IVs, etc. without trying to write it all down and risk getting something wrong.

Re-reading what I have written above really confirms what a joke it is trying to trade more advanced strategies with ASX options!

 

[Fox]

Hi Sails,

Thank you again for writing such a detailed reply. I do appreciate your thoughtfulness and effort.

When I first started, the ASX used to put out a monthly PDF with all sorts of option related info. It also contained the list of MMs that were quoting on each optionable stock.

I presume this PDF is no longer put out by the ASX? I would be keen to peruse it if available. I'll hunt around the ASX website to try my luck.

A broker once explainted that MMs quotes are handled automatically. When we put in a quote request, we simply see what has been invisible - albeit for a 30 second window of opportunity.

So, when you get a few levels of MD for that tiny 30 second window, I would think it's because of the different MM firms that are running automated quotes.

Aaahhhh! That explains why I saw what I saw. I still don't understand the need for keeping quotes invisible. Do the MMs hope to profit from stray orders that are totally overpriced? Why not just keep the quotes visible?

One little trick with that 30sec window of opportunity is to take a screen shot

Thanks for the tip. Will take the pressure off making a decision.

Re-reading what I have written above really confirms what a joke it is trying to trade more advanced strategies with ASX options!

Talking about jokes, I found this amusing game to play during the trading day. I once noticed a WOTM option traded at a ridiculous price. The MM's ask price was so high but some poor soul actually paid for the ask price.

I can't quite remember the ask price but I'll just assume it was $0.900 for discussion. I decided to see what would happen if I put a sell order in for $0.895. My sell order was quickly superceded by a new quote from the MM for $0.890. I then amended my order to $0.885. No prizes for guessing. The MM's automated system put in a new quote of $0.880. This went on and on until we approached prices nearing the day's IV. The MM's quote magically stopped and my sell order ruled.

This clearly shows that the ask prices are merely used to trap innocent newcomers. I recall reading an introductory book to options trading which suggests that you pay the ask price when buying options. To think that I used to be one of those poor souls.

 

[Grinder]

Nice disccussion you guys got goin here.

Aaahhhh! That explains why I saw what I saw. I still don't understand the need for keeping quotes invisible. Do the MMs hope to profit from stray orders that are totally overpriced? Why not just keep the quotes visible?

That would be my guess. The MMs seem to do as they please and can easily take an unsuspecting retail trader, the whole operation seems like a complete wrought. Glad I'm trading US now.

 

[Fox]

For the curious, these are the dreaded Oz MMs that I got off the ASX website (Appendix 3 of http://www.asx.com.au/products/pdf/asx_derivatives_and_your_company.pdf). The next piece of the puzzle is to work out which MM is assigned to a particular option series. The list of thieves include:

Citigroup Global Markets Pty Limited – Broker code AU905
Macquarie Options Pty Limited – Broker code AU908
Sandy Bay Trading Pty Limited - Broker code AU913
Liquid Capital Australia Pty Limited - Broker code AU916
Optiver Australia Pty Limited - Broker code AU923
Principle Strategic Options Pty Limited - Broker code AU928
Torque Trading Pty Ltd - Broker code AU929
Blue Shark Trading Pty Limited - Broker code AU931
UBS Securities Australia Limited - Broker code AU933
JP Morgan Securities Australia Limited - Broker code AU937
Timberhill Australia Pty Limited - Broker code AU940
SAEN Options Pty Limited - Broker code AU942
Susquehanna Pacific Pty Limited - Broker code AU945
JB Were Registered Traders Pty Limited - Broker code AU950
IMC Pacific Australia Pty Limited - Broker code AU951

 

[sails]

Fox - here is one from November 2005 - I haven't been able to find them on the ASX site for ages. I would imagine things have changed somewhat in the last 4 years, but a least it gives you some idea what I've been talking about - the info starts on Pg 2.

 

[Fox]

here is one from November 2005

Thanks Sails. I could not locate this info during my hunting trip around the ASX website yesterday.

I found it interesting that on paper (pdf file), the impression given is that of competition among MM for my humble single contract order. The reality of course is vastly different.

We are swimming among sharks aren't we.

I think that tight spreads can only result from large volume of trades. Having lots of MMs will only have a marginal effect on tighter spreads. I take the case of AMC where 8 MMs were listed. From observation, AMC sometimes trade as little as 8 trades per day. Only the most desperate among the 8 MMs will even bother with AMC IMO.

So we end up with the chicken and the egg dilemma. Tighter spreads lead to more liquidity. More liquidity leads to tighter spreads.

 

[wayneL]

Blue Shark Trading Pty Limited

The "Blue" is probably a redundancy.

 

[cutz]

So we end up with the chicken and the egg dilemma. Tighter spreads lead to more liquidity. More liquidity leads to tighter spreads.

I think the egg comes first here Fox,

The market makers also need to eat and until volumes increase a great deal we are going to have to take what we can get.

Even our biggest stocks have relatively little liquidity in the options, putting myself in the shoes of a market maker i wouldn't be falling over trying to attract a couple of contracts.

In contrast the volumes in the US are phenomenal, 1-2 point spreads are not unusual on the big stock options and the MM's can still afford to pay the bills.