Interview question: how do you make money with options?

[Appleseed]

Quote from erol:

I must disagree... does it not depend on the premiums you're receiving?

the way to make money in options 2 ways

1.. Sell a lot of otm options , puts and calls make small profits hoping the big one that goes against you doesn,t clean you out

2..buy a lot of otm options puts and calls. hoping you get a big one to cover all the small loses and make your day,month, year

cheers john

 

[guy990opl]

by selling them while managing the risk.

 

[dagnyt]

Quote from Agassi:

say some one wants to buy x at 100, then as a market maker, u would buy the same instrument from some one else at 99 or lower price and immediately sell it at 100. This in a very basic beginner sense.

is my understanding correct? also i know as a market maker u need to make markets. can u elaborate on details? how can joe sitting in home become a market maker in options? in stocks?

No. You are incorrect.

First you sell at 100. Afterward, you try to buy at 99.

If you are able to pay 99 while someone else is bidding 100, then the whole system has failed. The bidder should be able to buy at 99, the lowest offer. Or sometimes, the 99 seller is able to receive 100.

But it's never right for the market maker to steal that penny. Market making involves some risk - and they take it for as short a time span as possible. But your suggestion is naive.

Joe sitting at home must buy or lease an exchange seat, pass some tests, be cleared by the SEC, and have substantial financial resources. You also don't get to pick and chose your trades.

You cannot become a market maker.

Mark

 

[dagnyt]

Quote from Appleseed:

the way to make money in options 2 ways

1.. Sell a lot of otm options , puts and calls make small profits hoping the big one that goes against you doesn,t clean you out...


cheers john

Johnny,

Where are you getting the margin money to sell a lot of options?

Your method is guaranteed to blow up. Don't try this at home.

Mark

 

[dmo]

Quote from Agassi:

What exactly is "market making"? I know the basic idea...10 years ago, i had interviewed with spear leeds kellogg which was a market making firm. In stocks, u have the big i-banks as "market makers". My question is, can a retail individual be a market maker? that too in options? can u become a market maker? if so? how? do u have to buy a seat or lease a seat on an exchange?

My understanding of market making is that u have all the orders come to u and u match it all. say some one wants to buy x at 100, then as a market maker, u would buy the same instrument from some one else at 99 or lower price and immediately sell it at 100. This in a very basic beginner sense.

is my understanding correct? also i know as a market maker u need to make markets. can u elaborate on details? how can joe sitting in home become a market maker in options? in stocks?

No, the retail trader sitting at home is the person off whom the MM makes his living.

At the most basic level, it works like this. IBM is 100 bid, 100.02 ask. So the market makers are 100 bid, 100.02 ask, which means they're willing to buy at 100 and sell at 100.02 They probably have no opinion about IBM - maybe don't know what IBM does. But if the bid is 100, the MM wants to buy at 100. If the offer (ask) is 100.02, then the MM wants to sell there too.

Ideally for the MM, someone will put in a market order to sell, say, 1000 shares of IBM at the market. So the MM buys them at 100. And ideally again, a moment later someone puts in a market order to buy 1000 shares at the market. The MM sells them at 100.02, making a quick twenty bucks.

Let's look at what happens if IBM goes up or down 2 cents between the first transaction and the second. If IBM goes down 2 cents after the MM bought 1000 shares at 100, the new market is 99.98 bid, offered at 100. Someone comes in and buys 1000 shares at the market (100). So even though the price of IBM went down after the MM bought the 1000 shares, he breaks even.

But if the price goes up 2 cents, the new market will be 100.02 bid, offered at 100.04. If someone comes in a buys 1000 shares at the market, the MM now has made 4 cents a share, or 40 bucks.

So you can see that the MM has the odds on his side. If the price doesn't change between his buy and his sell, he makes 2 cents. If the price goes up 2 cents, he makes 4 cents. And if the price goes down 2 cents, he breaks even.

So the MM is the house, like in Las Vegas. Just keeps on betting with the odds on his side. He'll have losing days, but over time and thousands of trades, he'll come out ahead.

Up until a few years ago, stocks traded in increments of 1/8 of a dollar - 12.5 cents. That was a sweet deal for the market makers, and that's why they screamed when the minimum increment changed to a penny.

Market making in options is far more complicated, but the same idea. You keep making markets, trying to buy on the bid and sell on the offer, keeping your position as neutral as you can.

 

[dagnyt]

Quote from lemeeeplay:

more than 90% of open interest expires worthless every month.

I'd really like to know how this nonsense gets repeated so often. And I must confess, I've never seen or heard anyone claim 90% before now.

1) A high percentage of the open interest expires worthless - but that happens because the vast majority of options that have value are closed before they expire

The longs sell. The shorts buy. Thus, when expiration arrives, The majority of in-the-money options <b>no longer exist</b>.

2) You clearly imply that a high percentage of the original open interest expires worthless, but it's only a high percentage of the options that are still outstanding when expiration arrives that expire worthless - and that's a far different number.

Where did you get this - and why are you repeating it? It's just not true.

Mark
http://blog.mdwoptions.com/

 

[erol]

the way to make money in options 2 ways

1.. Sell a lot of otm options , puts and calls make small profits hoping the big one that goes against you doesn,t clean you out

2..buy a lot of otm options puts and calls. hoping you get a big one to cover all the small loses and make your day,month, year

cheers john

what about buying ITM options?

 

[lemeeeplay]

Quote from dagnyt:

I'd really like to know how this nonsense gets repeated so often. And I must confess, I've never seen or heard anyone claim 90% before now.

1) A high percentage of the open interest expires worthless - but that happens because the vast majority of options that have value are closed before they expire

The longs sell. The shorts buy. Thus, when expiration arrives, The majority of in-the-money options <b>no longer exist</b>.

2) You clearly imply that a high percentage of the original open interest expires worthless, but it's only a high percentage of the options that are still outstanding when expiration arrives that expire worthless - and that's a far different number.

Where did you get this - and why are you repeating it? It's just not true.

Mark
http://blog.mdwoptions.com/

From figure 4 ( call and put stats for SP and NQ)

http://www.investopedia.com/articles/optioninvestor/03/100103.asp

 

[TheoHornsby]

Quote from Appleseed:

the way to make money in options 2 ways

1.. Sell a lot of otm options , puts and calls make small profits hoping the big one that goes against you doesn,t clean you out

2..buy a lot of otm options puts and calls. hoping you get a big one to cover all the small loses and make your day,month, year

Hope isn't a very good thing to put your money into. Without an edge you're going to lose your shirt.

 

[newguy05]

dmo, dont the MM hedge at certain point. Using your example, MM buys 1000x at 100 from a sell order, lets assume it's not a very liquid stock, and all of sudden the bid is at 99.2 and ask at 99.5, so even if a market buy order comes in the MM will still lose 0.5.

If 0.5 is the risk threshold/policy, wouldnt the MM at this point forced to hedge his open position using options to become neutral again. Since they cant really hit the stop loss and sell the stock as they are the MM to begin with!

I guess my question is, as a MM you buy at 100, stock now at ask 99.5, there are no market buy order coming in, and your risk threshold just got triggered at 0.5 loss. What do you do at this point?

thanks

Quote from dmo:

No, the retail trader sitting at home is the person off whom the MM makes his living.

At the most basic level, it works like this. IBM is 100 bid, 100.02 ask. So the market makers are 100 bid, 100.02 ask, which means they're willing to buy at 100 and sell at 100.02 They probably have no opinion about IBM - maybe don't know what IBM does. But if the bid is 100, the MM wants to buy at 100. If the offer (ask) is 100.02, then the MM wants to sell there too.

Ideally for the MM, someone will put in a market order to sell, say, 1000 shares of IBM at the market. So the MM buys them at 100. And ideally again, a moment later someone puts in a market order to buy 1000 shares at the market. The MM sells them at 100.02, making a quick twenty bucks.

Let's look at what happens if IBM goes up or down 2 cents between the first transaction and the second. If IBM goes down 2 cents after the MM bought 1000 shares at 100, the new market is 99.98 bid, offered at 100. Someone comes in and buys 1000 shares at the market (100). So even though the price of IBM went down after the MM bought the 1000 shares, he breaks even.

But if the price goes up 2 cents, the new market will be 100.02 bid, offered at 100.04. If someone comes in a buys 1000 shares at the market, the MM now has made 4 cents a share, or 40 bucks.

So you can see that the MM has the odds on his side. If the price doesn't change between his buy and his sell, he makes 2 cents. If the price goes up 2 cents, he makes 4 cents. And if the price goes down 2 cents, he breaks even.

So the MM is the house, like in Las Vegas. Just keeps on betting with the odds on his side. He'll have losing days, but over time and thousands of trades, he'll come out ahead.

Up until a few years ago, stocks traded in increments of 1/8 of a dollar - 12.5 cents. That was a sweet deal for the market makers, and that's why they screamed when the minimum increment changed to a penny.

Market making in options is far more complicated, but the same idea. You keep making markets, trying to buy on the bid and sell on the offer, keeping your position as neutral as you can.