Market Makers

M

mapuata

Hi All,

as somebody who does not trade options I have a few questions for the seasoned traders...

I sit in an office where on the other side we have a bunch of option market makers (mostly former pit traders) who have been making a killing for the past few years, and this without too much apparent stress/risk.

I also know of several other similar sized or bigger shops here in London that seem to produce such results.

Now my questions... any ideas how they make their money so "easily"... do these guys get a lot of cream from their clients or are their valuation models that much better than those of other market participants?

The broker/market maker relation seems quite important which somehow makes me wonder...

All this applies to exchange traded options in Europe... are there any significant differences to the way the US work?

Many thanks in advance.
 
Read Connolly or preferably Baird to get an idea of what options market making entails. Do not expect any winning strategies to be revealed.
 
And btw, if your impression is that they arent stressed out, why dont you sneek over there in the morning and smell them. My guess is you will get a nice whiff of alcohol, maybe a few other things. Just an fyi, it is a very stressful job, even if you are good.

Mark
www.option911.com
 
From what I have read: MM typically are sellers of puts, buyers of calls, and they hedge by shortselling the underlying. (They sell puts, for the public typically buys puts for portfolio insurance. they typically buy calls, for the speculator does covered calls.) If the market rises or is flat, hedging with shorts isn't as necessary as it is with a decline and rising volatility. Options spreads are wide on a relative basis. Typically the bids and asks are hit, so the MM is always getting the best deal on options transactions. Plus his commissions are negligible. I am sure there are other reasons for MM's to profit.
 
ok, i may not have been clear...

i can see that they have some degree of stress and i also do not expect anybody here to reveal me a winning strategy (trade myself and wouldn't reveal anything strategy-related to others) but I would just like to hear from people who know about this specific business model (to me it seems a hybrid between a traditional bank trader and a local futures trader) if there is a way to tell how much their edge is "benign" paper and how much is genuine edge?
 
As a former MM, its not that there is any secret strategy, in fact most individual MM’s tend to manage their positions in their own personal style. The big difference is in these times there are not a whole lot of stand alone equity options market makers left. Most of todays MM’s are part of a larger group and they manage the net position as part of a dispersion book.

In general MM’s make their money off of order flow, they don’t have individual clients per se, they are exchange members and they have access to the order flow which gets sent to that exchange. Here in the US all the individual equity options are multi listed on a number of exchanges and pure retail customer orders automatically get the NBBO and all MM’s have to participate in the NBBO. Market Making today is far far less lucrative then it was in years past simply because the playing field is a lot more level and the multi listing of options as tightened the spreads. Remember they make their money taking the othe side of trades and doing it for perceived edge, then they have to manage the resulting positions.
 
I used to have a pretty specific routine, particularlly when I made markets in index options. I for the most part always traded with an axe and a game plan and I didnt let paper dictate the over all structure of the position I wanted. of course since you have an obligation to make a market in every option on the underlying many times you have to do trades you dont particularlly want to be in but if you did them for enough edge then you could always trade around them. I rarely traded direction.
 
Wouldn't be easier and give you more confidence to get out of your chair, walk ten steps, and ask one of those people that are making a killing, instead of asking anonymous people on a message board :confused:

I don't say that just to be clever, it is imperative as a prerequisite if you want an accurate answer. Asking someone that is not making money __now__ in trading is silly. I don't care if they made billions and were MMs two years ago. If option MMing is not your profession today you have little or no weight with me. I can flatly tell you that there are options MMs that made money as little as three years ago that would not stand a chance as an options MM today. It is fantastically more difficult than ever.

One further word of advice. Many people you see on floors are what are termed "green light red light" MMs. They are not really MMs in the sense that say we are. They are fed numbers from a model tweaked by a strong trader, and asked to make markets around those numbers. That requires almost no skill.
Quote from mapuata:

Hi All,

as somebody who does not trade options I have a few questions for the seasoned traders...

I sit in an office where on the other side we have a bunch of option market makers (mostly former pit traders) who have been making a killing for the past few years, and this without too much apparent stress/risk.

I also know of several other similar sized or bigger shops here in London that seem to produce such results.

Now my questions... any ideas how they make their money so "easily"... do these guys get a lot of cream from their clients or are their valuation models that much better than those of other market participants?

The broker/market maker relation seems quite important which somehow makes me wonder...

All this applies to exchange traded options in Europe... are there any significant differences to the way the US work?

Many thanks in advance.
More...
 
Quote from nitro:

Wouldn't be easier and give you more confidence to get out of your chair, walk ten steps, and ask one of those people that are making a killing, instead of asking anonymous people on a message board :confused:

I don't say that just to be clever, it is imperative as a prerequisite if you want an accurate answer. Asking someone that is not making money __now__ in trading is silly. I don't care if they made billions and were MMs two years ago. If option MMing is not your profession today you have little or no weight with me. I can flatly tell you that there are options MMs that made money as little as three years ago that would not stand a chance as an options MM today. It is fantastically more difficult than ever.

One further word of advice. Many people you see on floors are what are termed "green light red light" MMs. They are not really MMs in the sense that say we are. They are fed numbers from a model tweaked by a strong trader, and asked to make markets around those numbers. That requires almost no skill.
More...


We used to call those guys box monkeys. I even recall the time when Timber Hill's guys had those screens with the colored blocks mounted on the sides of pits which told their MM's the markets to be on.

Do you really expect to walk into someone's office and ask a question like "hey are you making a killing these days making markets in options?" and expect to get any better an answer than you would here? LOL

There are guys from 3 years ago and 5 years ago and 10 years ago and so on who would not make a dime today, just the same way there are plenty of guys who are MM's today who would not have made a dime in other time periods. The point you were trying to make was exactly what?

As far as having weight with you, you were not the one asking the original question thus the way you weight things is pretty much moot in this thread.

I would agree that in many ways its more difficult to make money as a stand alone MM these days in equity options, of course there are far fewer stand alone “locals” these days in multi listed equity options.
 
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