Well, if you're truly hedging equities with options, wouldn't you want to be? Now gamma scalping and looking for an IV pop is another animal. Those are beautiful trades when you can time them somewhat decently. But how would a MM deal with that when IVs were so high earlier this year? thx
I've been an equity option marketmaker myself and most of the MM's on the floor were delta neutral. In the extremely liquid crowds, like the index, MM's usually hedge option series/constructions with another serie/construction. In the funds/equities that were not liquid enough to do this (which goes for almost all equity options) we just hedged the delta's with the shares. Of course, hedging, even with shares, was not ALWAYS possible and sometimes a MM would be bullish/bearish, just like any trader. However it would depend on company policy how to deal with that (some companies like Timberhill just didnt allow ANY personal tactics/strategy at all and their MM's were nicked 'robots', since they were just completely instructed by their HO when to buy: HO just set the volatitily and they'd just buy below IV and sell above, lol)
also, there's no such thing as 'the' market maker, just as there's no such thing as 'the' daytrader. MM's would come in all kinds of flavours, ranging from dumb ones (timberhill) to very smart ones (optiver) and their strategies would of course be quite different.
In the SandP pit the market makers, or locals, get hit all the time. About a month ago a 20 year veteran burned his account, and has never been seen since.
I have met two types of options market makers: the ones that like to sleep at night but bleed slowly (long gamma), and the ones that have never seen an option they like (short gamma). The later don't really sleep well at night - you could understand how these guys make money, but like enjoying a hot dog, maybe you are better off not knowing how it is made. The ones that are successful imo know when and what to be short gamma, and what not to be. But other than 2008, short gamma rules the options markets. The way you trade is hugely influenced by your cost structure and the kind of flow you are likely to see. Remember, options are mostly used by large institutions as insurance (although I think hedge funds are now (always ?) using them to enhance returns by using money (and therefore leverage) more efficiently). This means that generally, market makers tend to get the part of the distribution that the "market" doesn't want. So if you get Bank Of America paper, you are likely to trade one way. If you are mass quoting options and that is where most of your fills come from, you are likely to trade another way. You guys always want to know what the holy grail is. The holy grail is someone giving you so much edge that you can work to turn that edge into a box by working the synthetic equivalent side of the flow you are getting (other than some insight into arbitrage opportunities, but usually that is limited in the size you can do). Outside of that, it is style and cost structure. Most people like to run their trading like a business, and that means mostly leaving with more money than you came into the day with. That means usually selling more options than buying them. That works, until 2008s come along and pulverize everyone in sight.
just so you know.....these people loose money when trading for the firm(not just daily duties). my bud is the spec. for 1 of the top sp 100 companys, and when he tells me about getting killed in a pos., I can't believe he took the position. (no options hedge) some think its like the old days of having the"book" right in front of you and there would be no way to lose. if he was running some kinda rat, i could see. he's got about 10 years exp. and net net.....he makes money at the end of the year for the firm.
Out of curiosity, how do you measure the "dumb ones vs the very smart ones" as profitability doesn't seem to be your main criteria?
I measure the "dumb" ones as the ones that would sell me 1000s of flies at credits to me. It happens every month. Yesterday it was GROUP ONE/SP. TBT Jan'11: bot 4500 47c 8.25 bot 13500 51c 6.50 sld 18000 50c 6.975 For you home gamers, that's 15c CREDIT on 1x4x3 fly. And as for Petterfy and company, they (you) have been punished the same way.
out of curiosity, how are you implying timberhill are more profitable than optiver? please bear in mind optiver do not have a retail broker on the side to simply fill order flow. thanks