I am an experienced option trader and know all of the basics. I have a math/statistics background and studied derivative pricing for an actuarial exam (although that was quite a while ago) and understand the general idea behind most of the parameters although now I tend to think of them more in laymans terms (such as the fact that options decrease in value more and more quickly as expiration approaches) and have some understanding of market maker hedging strategies (or at least the ones they should be using) My questions are mostly about market behaviors that almost seem like cheating, despite the fact that I am not trading in volumes significant to option open interest (but perhaps significant if entry prices and time in positions are considered) Here is a list of behavior I see: Trades almost immediately go against me, but more significantly than the amount required to trigger my limit orders. As soon as the order is filled, the underlying moves significantly in the other direction. There is what I would describe as a large amount of resistance to my trades becoming profitable. Large limit orders appear as barriers as the trade nears profitability, the option bids are below theoretical prices nearing that point, and there are often large price movements in the other direction on much lower volume if the trade becomes profitable such that I often need limit orders already in place right near the threshold of profitability in order to have any hope of getting out positive. When I do get out, the price may almost immediately move in the direction that would have made my trade more profitable and to a large degree. This kind of behavior lessens the longer I am in the trade. On stocks where there is an extreme amount of volatility where I know many people other than me are constantly selling and buying options, there seems to be a great deal of price fixing behavior. Many people on stock forums recognize this (aka price pinning), and often times it seems that these chosen price points are relevant to nearby option open interest. That is after large movements up or down reverse movements of the same or greater magnitude on lower volume occur on what I assume is HFT trading or sudden lack of liquidity in one direction. So assuming this is not paranoia, the people making the market for options and the underlying are obviously the same people and participating in non delta neutral strategies. Is this legal (assuming it can be proven)? I was under the impression that price fixing was illegal. Also is anyone aware of any hedging activities that could explain this without it being strictly price fixing (or perhaps grey borderline behavior)? Does the recent exemption to the Volcker rule for market makers affect this (To where they can engage in price fixing under the guise or ambiguity of successful market making?) Finally, this behavior seemed to occur more the longer I have been trading. Initially it seemed to be much easier to make profitable trades. Is it possible my retail broker could be relaying information about my trading activity if I was to be identified as someone who could potentially cause a lot of market maker losses?
What you percieve as "price fixing" is simple feedback from delta hedging, if anything it's bad for the MMs and good for the ouright traders. If every vol player is long gamma against an outright seller, big moves will be quickly reversed, volatility would be muted and the underlying will gravitate to the strike price (max gamma). If every vol player is short gamma against an outright buyer, big moves will be exaggregated, volatility will be amplified and the stock will drift away from the strike price. The rest is pure paranoia, since I suspect that your trades are not significant enough in size to warrant any sort of front-running or pennying. What U/L are we talking about, btw?
Well, I am an experienced options trader and I do think the whole world is out the get me. Not in terms of options trading, of course, but in every other aspect of my life.
Well I have traded in the thousands of contracts, but I have toned that down for the time being. I see subpennying activity all the time, and I don't think it is limited to me at all. For instance if there is a bid ask spread and I place a limit between it, it is immediately insulated with limit orders that go through before mine. I get around that activity by simply waiting for a larger movement in the right direction. From what I have read, delta hedging cannot be used to fully hedge risk from selling options and empirical data implies that other strategies are being used. http://people.stern.nyu.edu/lpederse/papers/DBOP.pdf http://faculty.chicagobooth.edu/geo...uments/The_Puzzle_of_Index_Option_Returns.pdf These are basically explaining how traditional market making strategies are not being used and why. As to the other person's comment, I am sophisticated enough that I can identify when activity is statistically significant. This doesn't occur so much on highly volatile stocks but more on stocks that do not have a large amount of human trading volume where I very might well be one of few non hft market makers making trades. However I am not so much implying that they are perving my account as I am that they might be using non neutral strategies against all option traders (although given my previous track record for making hundreds of percent returns in single days, they could be)
I don't even know where to begin, seriously. "Run Forrest, run!" (a) If you are an "experienced option trader", you should have an idea on how MMs run their option book. It's all about building a positively accruing book with good relative value plays. Delta hedging is a major part of it and it's not going away any time soon. (b) I can talk about the market making process and book management for hours, but it seems that I am wasting my time here - you should read Option Market Making, it's a bit aged but it's a good start. (c) Avoid most academic papers on derivatives unless they come from a handful of authors with the industry background.
How is it obvious that they are the same people? Are you saying that non delta neutral strategies are illegal?
Why would a textbook on theoretical market making techniques be more accurate than quantitative measurement and profiling of what is actually happening in the market? What it is saying is that someone has to bear the opposing risk on a options contract, which really is common sense. If a market maker delta neutral hedges they just pass the risk on to someone else. They cannot do that if there is no one willing to take it. Who is going to take it? Another market maker? The buck cannot be passed on forever. If you are talking about the large market makers, they may have to use other strategies as well.
(a) Delta hedging transforms terminal distribution risk into path-dependent volatility risk. This means that at a certain price (i.e. at some level of implied vol) any MM (or other vol player, e.g. myself) would be happy to be naked short or long an option. The residual risk is the convexity risk and it's up to the market maker how to hedge it - usually it's done via spreading it against something that is relatively cheaper risk. E.g. a market maker that got lifted on a bunch of front month ATM options might buy second month options to hedge, in process creating a relative term structure trade. (b) Your experience as a day trader in electronic markets has very little bearing on the actual world where large vol flows happen in IDB. Reading a text book will actually make you an "experienced option trader" as opposed to a wannabe that has traded a few contracts. Option trading is arbitrarily complex, but there is a certain understanding that you need to develop before people stop laughing at your statements. (c) What exactly is a "large market maker" in your mind?