question about index option trading

[orangelam]

i tried to explore the bid/ask price change before market open. for example, hong kong hang seng index option pre-market starts at 09:15am and market starts at 09:30am. when the pre-market session just started at 09:15am, i found that the bid/ask price for some options vary a lot, say the price at this second can be 200 whereas next second is 170. after 1 minute, the prices settled and move reasonably.

anyone knows the reasons? and for you guys trading options, would you trade just within several minutes after the pre market open?

don't know whether this similar issue happened in other option markets. if yes, pls share your thoughts. thanks!

 

[Parra]

I would never recommend you to trade right at the beginning of market opening, you should wait a while for prices to consolidate, especially if you are going to trade options.
To the opening and beginning of the market the money that approaches is the one of the retail, and the intelligent money, or of the big hands, there are enough theories that concentrates in the last hour of the market, in fact, statistically, I that am operator of Options, generally it is more profitable to wait at the end of the market to make the trading and the adjustments, but never you do it when you begin the session, give him at least one hour so that the prices are consolidated.

 

[tommcginnis]

after 1 minute, the prices settled and move reasonably.

What you describe is a 'thin market' and is repeated over and over, whether for equities, options, tomatoes, or used parts prices for antique cars. Doesn't matter: the crunch of many-buyers and many-sellers squeezes the bid and the offer together. In a thin market, there is no squeeze: bid and offer will be far apart.

 

[quant1]

Let's assume the quotes are from market makers. Most market makers have roughly the same process to build quotes for an option:

1. Look at the future/equity order book for the option underlying.

2. Calculate the option price with spot set to both the bid and ask price from step 1 respecrively. This will yield two prices which will be the option bid and ask. Note that some option pricing model will be used, say Black Scholes.

3. Look at the option order book and see where your bid/ask will fall relative to the market. Add some edge to your quotes and perhaps intentionally step in front of other market markets to get priority.

Based on this process, if the underlying market is moving quickly or wide, the options being quoted on that underlying will have corresponding dynamics (via roughly the process detailed above). The reason this process is common is that market makers typically trade risk flat, and therefore hedge option delta quickly. By building quotes by "leaning" on the underlying order book, they immediately know where to hedge underlying if a quote is filled.