Yesterday, I was talking to a friend working in a hedge fund and he told me that trades, usually large ones, labelled as "Call with Delta Hedge" come from two different operators. As you know, these trades have an option part and a companion stock part. He explained me that they are triggered by the option transaction, which is directional and made by a given trader, and completed by the stock tran saction which is made by the market maker only for hedging purposes. For instance, on July 3, Chamaleon market reported this recent trade on TRIP. It was initiated by the buying or selling of 3,000 C25 July 18 exp. and was completed by the almost simultaneous buying or selling of 120,000 shares of the underlying. In agreement with my friend, the first trade was likely an informed one, whereas the second one was made by the MM, the same who sold or bought from him the 3,000 options, only for hedging his position., i.e. considering a delta of 0.4: 3000 * 100 options = 300,000 shares, multiplied by 0.4, you get the 120,000 stock figure. I was instead under the impression that trades like these came from a single investor who, in case the options were bought and the shares were sold, was trying to exploit a stock movement in any direction. Or, in case the options were sold and the shares were bought, to get a profit if the stock price remained in a given range. Who is right? Me or my friend?
You are. They are traded as a package to be delta neutral. The investor gets a better price (in vol terms) because the facilitator (typically a large bank) won't take on the delta risk. if the bank was taking on the delta risk you wouldn't see a 120,000 share block print. it would be traded via some algo in smaller clips like the rest of the normal orders.
the client says he wants to buy 3000 calls for $_____ tied to stock at $_____ price on a 40 delta. Market maker agrees and sells 3000 calls to the client and buys 120,000 shares from the client at prices that equal the total basket value agreed. The price for the options have to print on the exchange within the bid/ask of the market so as the prices move due to delta the market maker can adjust via the stock leg.
So, my friend was right. If the trader buys the option, the MM sells him the option and buys the stock. I thought instead that the trader was both buying the option and selling the stock
the MM would do that but it wouldn’t be as one clip. Remember every transaction needs a counterparty. You cant just find a guy to trade 120,000 shares the second you need to trade the options. You will have to work it. this is why institutions trade delta neutral. They put on the options and then unload the stock themselves (unless they only have a vol view) your friend is right but in this example he’s wrong.
your friend is right but in this example he’s wrong.[/QUOTE Thanks, but then, in this case, if the options were bought, the stock was bought (my friend interpretation) or sold (my interpretation)?
likely whoever bought the options, sold the stock (the whole trade is delta neutral). what we dont know is which side the market maker (liquidity provider) is on.
Thanks for your insights, but would that kind of information be relevant? I mean, since it is delta neutral trade, that stock could go either way and still the trade be profitable.