How Locals Make Money in Options

Im talking about locals in the commodity options pits. How do they make their money and what stratagies do they use? I have heard they are usually always long the option.

On the flip side. What about the options that are traded electronically? How do the daytraders/locals make money and what stratagies do they use when trading electronic options?

Just curious as to what these guys do (spreads, selling, buying, volatility, etc)

Thanks

 

there are two ways to answer this: a long one, I will leave to others, and the short one: they buy below theoretical value and they sell above theoretical value, and then they delta-hedge accordingly.

 

For a longer answer read: option market making by Baird.

 

this is for market making...

read baird. most these pit guys are put into there positions because they are making markets. a broker says whats the quote for atm straddle and the pit guy says 50 at 100.

for electronic options MM. its all computers streaming quotes. theres a few guys who watch the computers and adjust parameters.

 

with b/a spread shrinking on daily bases , can someone give a simple example of how it's works ? Q's atm's spread is at penny now...so does their model calculates theo value at 2.56 1/2 and MM shorting option at 2.57 or going long at 2.56 ? Also , delta-hedge doesn't works against large overnight moves.

 

Here is how they make money. They hold a position composed of many legs. Each leg or set of legs can be replaced with one or multiple legs (stock is part of what I refer to as a leg). What they do then is replace a leg or a set of legs, by a cheaper leg or a set of legs. That is the essence of what they do.

Now to replace a set of legs by another set of legs (cheaper if you buy and more expensive if you sell), you need relations to guide you. They are: (1)Conversion/reversal, (2)shortbox/longbox, (3) jelly roll. (1) involves put, call, and stock at each strike. (2) involves two strikes, same expiration. (3) for each strike, two expirations. You see, there are many of these and their combinations. A software can show a cheaper/most expensive way to do things.

While waiting for the public to trade against their inventory, they manage risk and most often hold positions which are theta positive (to earn income to feed their family). They also hoard cheap wings so that they can fly if winds blow throw their position when the underlying takes off up or down.

 

In reality the way mm’s work has changed dramatically. Standing around trying to leg into a jelly roll or a box or working conversions and reversals ended more then a decade ago. Virtually every equity options market maker these days is simply a box monkey who manages order flow as part of a centralized dispersion management strategy. You’ll find very very few “locals” left in equity options because of the tight spreads. What you do find is guys who stream in quotes in dozens to over a hundred different books in small size ( like 10 up ) if they’re what used to be called a “local”. You also have the big firms who stream in larger size and trade hundreds of books. They take tiny edge and try to do it in big volume.

Of course every decent order is shopped all over the place and payment for order flow agreements rule the markets too.

 

Thanks for replying

Actually I am more interested in how locals make money in the almost 100% pit traded options. Such as the treasuries. eurodollars and agricultural options pits. Do they actually day trade the options or do they get themselves a good position and hold it for a while?

Treasuries and Eurodollar options seem to be a lot more complex than equity options which I guess is why they are almost completely floor based and look to stay that way for a long time.

Any help on the subject would be greatly appreciated

YT

 

You wont see a "local" trade with another MM in almost any pit in the world, not directly at least. Virtually all MM's will not cross the bid offer spread and give up the theoretical edge unless they're realyl jammed up.

 

Well, it does not. But some (roughly half) overnight moves will be in favorable direction, so they balance each other.