Keep in mind that if he only has a position in one strike and is delta and premium neutral, then he has either a reversal or a conversion, in which case he locked in his profit or loss when it was executed. What I think you mean is this. Imagine a local buys 110 calls at a lower IV and sells 111 calls at a higher IV, and manages his position until expiration such that it is at all times perfectly delta, vega, theta and gamma neutral (this is impossible of course, but just for the sake of argument). At expiration, yes, he will realize the theoretical value of the spread. Specifically, let's say that at a volatility of 50%, the 110 calls are worth $3 apiece, and the 111 calls at that volatility are worth $2 apiece. So the spread at that moment has a theoretical value of $1. He buys a hundred spreads for $.90 each, a theoretical edge of $.10 x 100 = $10.00. If he can manage his position with perfect delta and premium neutrality until expiration then yes, at expiration he will realize a profit of $10.00. As an early teacher of mine liked to say, "All options go back to the sheet (their theoretical value) at expiration."
Good thread, I would add that rather then sheets these days most guys carry a hand held with real time pricing on it and they can execute underlying trades with the hand held too. I remeber the old days of sheets where the CRT guys used to have to sign their trading sheets in and out and shred them at the end of the day. If they lost a set, and they used to have a chit load of sets by days end they were in deep crap.
?....wtf?....do you mean the trader had to run wind-sprints and do "sets" of push-ups and sit-ups as "punishment"?
LOLOL - yeah, CRT was INSANELY secretive about their stupid sheets! I did once get my hands on one - a CRT trader dropped his sheet and I covered it with my foot until he was gone, then I stealthily picked it up and pocketed it. I took it home and was so excited that I was about to learn the secret of the universe - I got it home and compared its values to the values on my sheet - the values were a little different but the truth is it didn't tell me shit.
Lets face it... there is no secrets at all in fact in the old days the markets were wide enough only the really new guys needed to use the sheets. Whats so hard in the CRT sheets that they needed new sheets every hour of the trading day? The print of their sheets was so small who the heck could read it? I traded some index products where the markets were wide enough that I would run 1 set of sheets in the morning with the prices 10 index points apart and use them all day. The stuff is so tight these days they fight to make 3 cent wide markets in equity options, have fun I dont need to do that anymore.
Sounds like my experience - one day I was trying to leg a spread, when an order came in from outside for the exact spread I was trying to leg - at the same price - AS A SPREAD. The locals filled it. So I left the pit, called in an order anonymously to do the same spread I was unable to leg in the pit, and I got filled. That's when I knew my days on the floor were numbered. Why stand there all day when I could get better prices by calling in orders?
I never got why some MM's would not trade with any other MM or FIRM guys. WTF? do you think they really know more about how those options are priced then you do? And if they do why the heck are you making markets in that stuff then anyway? I would trade with anyone who wanted to hit my bid or take out my offer, retail, firm, mm or whatever. Used to crack me up when a floor broker didnt like the price in some multi leg order he brought to the crowd and would shop it away. Then he would come back and when no one beat our pits price he would ask for that price back. We all knew they shopped the piss out of the order and leaned on us, sorry pal you had your shot at that price. Ahh the good old days
That's how it was in the nat gas & crude oil options pit - locals and market makers would trade with each other all the time, in addition to the paper brokers and other firms. Good times.
Yes, it's so much about psychology, isn't it? The public thinks the floor traders are like Mr. Spock, but most are just dumb shits driven by the same herding instinct as everyone else. I still use that psychology when I call in an obscure spread order into an options pit. I wait until a slow day when the locals are bored and hungry to do something - anything. Then I get a quote on the spread, then bid near their bid. Then every few minutes I have the broker go a tick better. That gets them salivating and circling like sharks at feeding time. Often they're so afraid someone else will beat them to it, someone jumps in and does it too early, and I get filled at a good price. If I were in there as a local and bid that same price I got filled at as an outside customer, nobody would even look at me.
If I were to go back on the floor today, I think the one pit I'd most like to be in is crude options. Playing the skew is my favorite game, and the crude skew rocks and rolls. One day the calls are pumped and the put skew is flat, a few days later the puts are pumped and the calls are flat. Looks like it would be fun to be there. Plus you've got many active months, and all the options volume is still in the pit. What didn't you like about it?