My understanding of market makers is they're not after the nickel though. And I'd assume they are hedged and not carrying large overnight risk for a nickel. But I don't see the similarity of what you're doing to a market maker? Also, you are correct that nickel options aren't a certain road to failure. It can be done I'm sure. There have also been a few successful high-wire walkers over the years.
How do they hedge for OTM options with delta close to zero, especially as we get close to expiration? That's exactly the same scenario as what I'm facing here. They do have large* overnight risk. *"large" is your word, not mine.
If they were *not* after the nickel, you'd see 0.05 bids throughout the entire option chain, at any strike where there was open interest in the other direction. And you don't see that. I don't believe that market makers pay 0.05 a contract to clear out the deep OTM/ITM options on their books.
Here's my suggestion. If you sold the 12.5's for about a dollar and they're now worth 0.05, what are the 10's worth? Possibly you can now buy a 10 call for 20-30 cents. If you can, you've locked in your profits ( 0.70 gain now is a certainty since the 12.5's are not naked anymore) AND you can also have the opportunity for the 10's to become very profitable if the market just happens to revert toward the mean. Suddenly your maximum possible return from this position now becomes 3.20 (2.50+0.70), and you cannot lose. I like sleeping comfortably at night, and this is a position that contributes to very good sleeping! This also gives a modest potential hedge for the rest of your portfolio in the event of a major surge upward over the next three weeks. My educated guess is that your ATM strategy doesn't really like sudden major surges of the entire market in either direction, especially since you are using both puts and calls in your portfolio. By the way, I heartily endorse the idea of not using all your margin. Powder must be kept dry and ready for use in emergency situations. The June 2009 market is not that kind of market at the moment, but no one knows the future and it pays to be able to play defence if necessary at any moment. No margin availability means that defence is weak at best, and most likely almost completely absent.
JohnGreen makes a very good suggestion. Since I don't do "naked" I missed legging into the spread. And when I spoke of hedging before I neglected to state the fact I'm typically using individually hedged position to start with. I was discussing hedging on a portfolio-wide basis. And on the nickel thing... Earlier I was trying to say market makers are traditionally after the spread (which for the option in question happened to be a nickel - so maybe some confusion there). We were discussing the merits of capturing the last nickel of time decay - different nickel. And market making hedging and clearing is well beyond the scope of my text. However, I would hazard a guess if they sell an option for a dollar they've long ago offset it by the time it gets to a nickel. So I don't think we're comparing apples to apples again.
Actually, I'm also short the calls at 10... so it's basically a repeat of the other question: should I cover... I'm mostly joking about not sleeping at night. My stomach has become mostly immune due to continuous practice, although the first few weeks I was a nervous wreck. I've got the 1000 yard stare at this point. I definitely hate the gap ups/downs, but I like intra-day big moves up/down... since it means gamma drops and my hedging gets much easier. Today, for example, PALM announced positive results after the market and it looks like it's going to open up +15% tomorrow. Not so good for me, since I have synthetic calls at 14 and 15 which are going to get absolutely smashed. But that's life on the ATM edge.
1) LOL. You must have me confused with someone else. I haven't mentioned catastrophic failure. What I stated is that I believe that the risk/reward of a naked 5 cent option is lousy. If you believe otherwise, so be it and we agree to disagree. 2) Do you really believe that what you and I are doing is anything like what a market maker does? At best, we get their droppings. Have you locked in many risk free conversions and reversals etc. today or lately?
You're right. I think it was Mark that said it was "near certainty" 5 cent options would turn to catastrophe. I'm still torn on the risk/reward, and I understand both arguments. You've clearly reached your firm conclusion, and I'm not at all trying to talk you out of yours. I'm still working on mine, as is appropriate for the way I'm hedging. None. I don't really know enough of the internals of a MM to know the breakdown of their business. But it seems likely they get paid from three ways: ask/bid spread, temporary arb, and delta hedging at a lower vol then the IV they sell at. I don't get the first two, but hopefully I can get some of the last.
I'd go with a guess of delta neutra for hedging that riskl. It's nowhere near risk free but their advantages are light years ahead of ours. I'd bet that they're close to transacting before you/I even kow it's time to transact. Perhaps Mark or other real former_mmakers will enlighten us
Well, that dogmatic poster on page two coerced me into believing that it's better to close I think it's a simple process for you. If you're comfortable with the risk and if you can find something better then you close the 5 ct option and go elsewhere. If you can't find something better then you ride it for basis points per day. OK, done deal. Ready to clean up that world hunger issue ??