The specialist decides where to open the price of the stock and decided to gap it down to a price level where the stock was trading 7 months ago. 7 months of stock gains for the longs vanish in 1 day. Doubtful everyone has so much cash just sitting idle in account to cover margin call on the open. The specialist can use the gap down to square up position and start again.
my friend works on the floor. it's pretty amazing what they "don't do or don't know" that you would think they would have to know to get the job. when he told me about what took place last year at his station I didn't believe him because its something any chartist would never do. i'll think about being more specific, maybe. and I believe nitro is correct....no hedge in options market. i'll ask my bud. I think I asked him about 2 years ago and he said no, not since. I would have assumed something like that was being done . i'll try to find out.
It is rather complex for option MMs. There is always some hedge, but it depends on the month and the expiration cycle.
pretty sure the op wasn't talking about mm'ng equity options... to the op... they hedge. if they're exposed, it will probably only be a certain % exposure before the risk desk gets up there ass. real mm's are interested in spread and try and hedge off directional risk, if they're not, they won't be mm's for long. the only exception to that rule, is if they're bankrolled large enough and can afford the infrequency of quoting wide.
That's what I was thinking. It's great when he can exaggerate the move when the news is in his favor, but what if the news is against him and it continues to trend up? I have a lot of trouble believing that gaps are a primary way for a specialist / MM to hedge against losses.
But I have some trouble with this as well. How do equity market makers hedge with options while remaining vega neutral? If this is possible, I would like to know how. In other words, if it is possible to remain delta neutral, and vega neutral, while your equity position is constantly changing... sheesh, I am in heaven. But if there is such a way, I don't think theta would be my friend. What am I missing here? [Edit] P.S. All of my comments are under the assumption that the original poster was referring to equity market making.