SPX Credit Spread Trader

[dqtmg2]

Quote from ThunderChicken:

Wow Maverick! I got to learn to do the dissection like that.

But the only way i can lose 2 pts is if GOOG is 470 on expiration, right?. I can deal with that.

No, you lose 2 points if GOOG is at or below 470; make 8 points if GOOG at or above 480, and breakeven at 472.

 

[El OchoCinco]

If you are not ready to handle dissection or synthetics (Long Collar can equal bull spread) then simply put the position on paper and map out what it does at different prices. This is old-fashioned but the clearest way to see what really happens to your position.

Quote from ThunderChicken:

Wow Maverick! I got to learn to do the dissection like that.

But the only way i can lose 2 pts is if GOOG is 470 on expiration, right?. I can deal with that.

 

[TrendSailor]

hehe - I just found a way to train the lazy SPX options market maker(s) to do what I want him to do to get in today.

Yesterday I could not get in on March SPX to the downside at all. There was almost no trading volume at mid point at the strikes I wanted with only a few bidding and asking.

Anxious to get in I watched and studied the options trading volume and price dynamics all morning. I then noticed a good down run on SPX and a fair increase in volatility. So I opened multiple PUT CALL spread orders in around the 1405/1395 in multiple accounts with multiple order sizes and premium differences between .05-.10 below mid point. I wanted to get in badly and was willing to give up some credit & make it as easy as possible for the market maker to execute something.

The order sat with no action for over an hour and SPX was dancing up and down around where it needed to be to execute. So I started whittling away the price and tweaking the order sizes and net credit price - still no joy. I then analyzed the options chain and noticed a relatively LOT of option volume trading around the 1400/1395 mark but discounted in net spread premium. That was deeper than I needed to go and I did not like the low premium that dropped off disproportinately with the higher demand.

I was frustrated but eager to get in. Then the market runs down even more and VIX bumps up again. So I put in what I want to call a "parasitic order" - a nickle under mid point on the lower & higher trading volume strikes to force something to happen. I simultaneously entered my preferred orders in two separate accounts from higher up at 1405/1395 but closer to mid point and with a much larger order size. I did not care which or if both sets of orders at either strike sets exercised. I just wanted to get in reasonably close to my targets on the friggin down spike as fast as I could before the down run vaporized.

After about 2 minutes of delay it finally forced the market maker take the bait. My lower order forced him to step in to normalize the b/a price spreads between the 4 adjacent strikes. He must have finally got off his butt to execute my preferred orders! Previously I think he was relying on natural trader buying and selling demand and was not willing to enter to facilitate.

My theory is the lower strike order I submitted made it glaringly obvious to anyone watching that the MM was previously ignoring valid trades that were ripe for execution. From my perspective he was getting very greedy for more slippage to more than cover his neutral hedge as the SPX dove deeper by 3-4 more points ( and still no trades). It also made it obvious to the floor and anyone watching that somone was ignoring more than fair bid/ask for my spread order in favor of making a higher commission/vig on the other higher volume trades. I got in almost immediately after I submitted that normalising lower strike order. Quite satisfied, I then immediately cancelled my lower strike orders since I was then set up for my March strategy.

Moral of the story - make your Market Maker work for YOU. Pat his head, scratch his belly, offer him morsels of food. In all seriousness it seems that its "tribal tradition" or "black magic" as to when a market maker will step in to "make the market" verse relying on natural market trader volume to fulfill supply/demand imbalances.

Now if I could find a way to train these guys to roll over and play dead and hold back the insane asking prices when I need to buy back spoiled shorts I'd be in trader heaven...

TS

 

[arizonadreamer]

Okay, could somebody give me a really, really, good explanation of this one?

Yesterday, around the same time frame, exactly 10,000 contracts of the March 1340 puts traded at .50 and 10,000 of the March 1360 puts traded at .70.

Assuming it was likely a put spread:

1) Who would put on such a spread? That's $20 million dollars at risk for the seller!!

2) If a MM took the other end of it, how would the MM hedge something like this? The seller receives 10,000 x .20 or $200,000 in premium. How could the MM possibly hedge this without just throwing money away? (Assuming of course the MM is not taking a directional bet.)

Thanks in advance.

AZD

 

[El OchoCinco]

Well at least the spread is almost 100 points OTM lol.

A friend how runs a hedge fund doing mainly spreads has about $50 million under assets so the size is quite possible with all the numerous funds out there in the millions trading spreads. So $20 million at risk is way under 50% of a portfolio for a lot of swingers out there.

I doubt the market maker has to hedge too much since he knows his risk upfront is only $200,000 but he could make his year on a rare bomb. I might assume wrongly that the MM has positions spread through the strikes and on a net basis is not as exposed as this position makes it seem.

Quote from arizonadreamer:

Okay, could somebody give me a really, really, good explanation of this one?

Yesterday, around the same time frame, exactly 10,000 contracts of the March 1340 puts traded at .50 and 10,000 of the March 1360 puts traded at .70.

Assuming it was likely a put spread:

1) Who would put on such a spread? That's $20 million dollars at risk for the seller!!

2) If a MM took the other end of it, how would the MM hedge something like this? The seller receives 10,000 x .20 or $200,000 in premium. How could the MM possibly hedge this without just throwing money away? (Assuming of course the MM is not taking a directional bet.)

Thanks in advance.

AZD

 

[arizonadreamer]

"I might assume wrongly that the MM has positions spread through the strikes and on a net basis is not as exposed as this position makes it seem."

I think the positions would have to have been huge naked options positions that were already established before yesterday.

To my knowledge, there were no other large options orders.

Do the big boys really have 200K to throw away?

AZD

 

[TrendSailor]

Quote from arizonadreamer:

[B
Do the big boys really have 200K to throw away?

AZD [/B]

When I think about these kinds of situations I can only conclude that there must be a lot of money to be routinely made in the b/a spreads on high volume. There is a reason these guys are Market Makers - they make a nickel minimum on every transaction just on the bid/ask spreads. Who really knows how much else on thin volume trades where they pick up "deals".

These guys must extract literally truck loads of this "pocket change" from routine market operations/facilitation. As such they must have enough cash and credit to make it (on average) more than "easy" to cover these kinds of larger orders.

I have always viewed this part of the market as a casino with the house statistically always assured to win. They probably only enter on one side of the trade if they are hedged or need to offset risk on another side (just like a bookie) of the ledger; otherwise nothing trades until some trader (sucker) comes along to take a crappy price. I suspect that they are pretty much on electronic auto pilot and can easily get their books balanced by taking other sides of the trades all over the strike spectrum at a discount (since they control slippage). This way they can rapidly get back to neutral by end of any arbitrary trading day.

I wonder though how many of these market makers actively enter as traders when they see deals that they know are too good to be ignored. All it takes is a few of these large blocks of cheap lotto tickets to go bad to make some market makers year/career/life.

I'd love to read a book on the "true confessions of a market maker" to see what really goes on behind the scenes. But I suspect if any ever leaked the whole truth they would have to leave the country to keep from getting their life insurance policies sold short by their fellows...

TS

 

[dagnyt]

Quote from arizonadreamer:



Do the big boys really have 200K to throw away?

AZD

No.

But, MMs get long and short lots of different options during the course of trading.

For any MM short the higher strike put, this order presented a great way to cover that secific short and allowed him to open a short that is les likely to bite.

Whether covering a short, or buying downside protection, the MMs can then sell other, better spreads with the opportunity to make a lot more money than 30 cents. The MMs could sell higher strike Mar puts, or open a short in Apr puts.

Note: in todays world, MMs don't take big risk. Thus, I would not expect them to sell lots of puts against the spread purchase. But, they would gain from buying this spread by allowing themselves to sell better put spreads, as they become available.

Mark

 

[arizonadreamer]

Quote from dagnyt:

No.

But, MMs get long and short lots of different options during the course of trading.

For any MM short the higher strike put, this order presented a great way to cover that secific short and allowed him to open a short that is les likely to bite.

Whether covering a short, or buying downside protection, the MMs can then sell other, better spreads with the opportunity to make a lot more money than 30 cents. The MMs could sell higher strike Mar puts, or open a short in Apr puts.

Note: in todays world, MMs don't take big risk. Thus, I would not expect them to sell lots of puts against the spread purchase. But, they would gain from buying this spread by allowing themselves to sell better put spreads, as they become available.

Mark

Thanks for the input.

So, who do the MMs sell to so that they may balance their positions?

How many MMs, for example, are doing the SPX contracts?

AZD

 

[TrendSailor]

Quote from arizonadreamer:

Thanks for the input.

So, who do the MMs sell to so that they may balance their positions?

How many MMs, for example, are doing the SPX contracts?

AZD

Mark may have more insight but I know there are at least 4 serious SPX market makers provided by Morgan Stanley, Citi Bank, Merill Lynch and others.

TS