The only ones who buy on ask and sell on bid are some dumb retails, what I was asking was if all retails offered and only accepted mid, where was the profit?
IV Smile and Firm Fundamentals
- Thread starter .sigma
- Start date
It is call dumb. Takes courage to admit it.
read up how market makers make a profit. There’s more ways MM’s make money than the spread.
Regardless of sub pennying since it isn't allowed anymore, how do we think market makers make money? I would say mostly charging a spread. They need to purchase order flow from a broker and by itself, this is a cost. They can provide liquidity to a broker or dealer, and they can take commissions from this. But I am fairly sure the net of this transaction is nothing compared to making markets for a big MM, the money is in making two sided markets, and it's easy to see why, especially in times of high IV or after earnings when SEC allows for wider spreads.
A good MM is going to price an option conservatively and set a conservative spread, filled at bid/ask is their best case scenario, but not the only one they can profit on. As long as you are filled at or inside the bid/ask but above/below (depending on if you're buying or selling) their market evaluation of the option, they will turn around and buy or sell the option on the other side of the spread. The beauty of making a two sided market.
Ex. Option bid/ask: .45/.55
You are short this option and submit the order:
your bid fill: .48
another clients ask fill: .53
The MM just bought an option for .48 and sold for .53
Inside the NBBO yes, and you probably thought you got a good deal. This is a wide spread, granted, but not obscene. Market makers profit on a spread like this could be enormous, at 10 cents maximum if both parties filled at NBBO, possibly 5 cents as above, and maybe as little as 1 or 2 cents.
Only the seediest mobbed up casinos have this level of edge against their clientele imo
I think this paper is going to be a foundation, a blueprint for further analysis. As the option markets grow in tandem with all financial markets we will see so many new unique features on how to analyze data.
We all know quantitative analysis is the way to properly assess option contracts.
Nobody looks at a chart of an ATM call price through time and draws support and resistance lines. But technical analysis can indeed be useful.
For example, measure the 30D implied vol when spot is above the 200sma and now measure the 30D implied vol when spot is below the 200 day moving avg. We all know when spot is below the 200, it's most likely in a downtrend, and spot tends to have larger magnitude movements (daily ranges). When spot is above the 200ma spot is trending up, stepping stairs consistently, smaller ranges, therefore lower implied vol. This is very interesting.
Now take it a step further and look at fundamental analysis. We all know each company (underlying) has a nature to it, acting a specific way inherent within the corporation. McDonald's price action is a lot different than Tesla. Well obviously the companies success/failure will be determinant of its place in these markets. Firms that are failing, deep in debt, will most likely be contending, and have larger movements in price, thus seeing higher volatility.
In this study they said "of the firm fundamental metrics chosen, leverage and liquidity were positively significant, while profitability, investment, size, dividend-price ratio, and book to market ratio were negatively significant, suggesting that a firm with a higher leverage, smaller profitability, size, and so on, is associated with a larger implied volatility."
Knowing this, a speculator can dig deeper into this and see if it has any validity, and maybe it does, and maybe we will even see fundamental option metrics on broker platforms soon enough, but this can have some buzz.
We all know quantitative analysis is the way to properly assess option contracts.
Nobody looks at a chart of an ATM call price through time and draws support and resistance lines. But technical analysis can indeed be useful.
For example, measure the 30D implied vol when spot is above the 200sma and now measure the 30D implied vol when spot is below the 200 day moving avg. We all know when spot is below the 200, it's most likely in a downtrend, and spot tends to have larger magnitude movements (daily ranges). When spot is above the 200ma spot is trending up, stepping stairs consistently, smaller ranges, therefore lower implied vol. This is very interesting.
Now take it a step further and look at fundamental analysis. We all know each company (underlying) has a nature to it, acting a specific way inherent within the corporation. McDonald's price action is a lot different than Tesla. Well obviously the companies success/failure will be determinant of its place in these markets. Firms that are failing, deep in debt, will most likely be contending, and have larger movements in price, thus seeing higher volatility.
In this study they said "of the firm fundamental metrics chosen, leverage and liquidity were positively significant, while profitability, investment, size, dividend-price ratio, and book to market ratio were negatively significant, suggesting that a firm with a higher leverage, smaller profitability, size, and so on, is associated with a larger implied volatility."
Knowing this, a speculator can dig deeper into this and see if it has any validity, and maybe it does, and maybe we will even see fundamental option metrics on broker platforms soon enough, but this can have some buzz.
Of course the "main" source of income is quoting the spread, that's their job. To provide immediacy, to provide stable liquidity. So be default this will be their main income. The problem is this isn't 1977 with open outcrys.
1997 the tightest spread was 12.5 cents, and as the tech boom and massive liquidity rushed into the markets we saw so much money flood into the system. That $0.125 changed to $0.0625.
Then the Island Exchange changed the game, and started paying market makers to quote a spread. This resulted in lots of MM's, and competitors following suit, causing even tighter spreads.
Thus market makers arb'd themselves! It's the same shit with commissions and fee structures. The money markets are adapting, it's a natural progression. We are seeing massive change relatively quickly. Moores law probably.
Gaussian is dead and power laws are whats poppin.
Thank you for your comments.
Makes sense, as I looked back, indeed I often got my fills a little above/below (buy/sell) mid and thought I traded like a pro and got a good deal, typical amateurish thinking.
If I replace the GBM/Gaussian in BSM with power laws, what is the equation I now use for my excel option price computation?
Question:
Why trade delta neutral in a binary event?
Typically, we assess the probability of the binary event, if it is, in our opinion, different from market, we vote (bet)?
If you establish a delta neutral set up, you are essentially trading volatility and not directional?