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    Option Market Making : Part 1, An Introduction: Extrinsiq Advanced Options Trading Guides, #3
    Option Market Making : Part 1, An Introduction: Extrinsiq Advanced Options Trading Guides, #3
    Option Market Making : Part 1, An Introduction: Extrinsiq Advanced Options Trading Guides, #3
    Ebook83 pages1 hour

    Option Market Making : Part 1, An Introduction: Extrinsiq Advanced Options Trading Guides, #3

    By Simon Gleadall

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    About this ebook

    Starting from first principles, option market making is explained in straightforward English. Separate sections discuss the strategy and business of market making, how option market makers typically determine prices and how market makers look to manage option portfolio risk. Simple but detailed examples are provided throughout. Three sets of exercises, complete with solutions, are provided to test the reader's understanding.

    Published by Extrinsiq, this is the third volume in the concise Advanced Options Trading Guide series. The series aims to present somewhat more advanced topics relating to options trading in a clear way with an emphasis on practice rather than theory.

    LanguageEnglish
    PublisherExtrinsiq
    Release dateFeb 22, 2021
    ISBN9781393782278
    Option Market Making : Part 1, An Introduction: Extrinsiq Advanced Options Trading Guides, #3

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      Book preview

      Option Market Making - Simon Gleadall

      OPTION

      MARKET

      MAKING

      Part I : An introduction

      Simon Gleadall

      1st Edition

      Extrinsiq Advanced Options Trading Guides

      © 2021 Extrinsiq. All rights reserved.

      First published by Volcube, 2013. This edition first published by Extrinsiq, 2021.

      Disclaimer

      This book does not constitute an offer or solicitation for brokerage services, investment advisory services, or other products or services in any jurisdiction.

      The book’s content, tools and calculations are being provided to you for educational purposes only. No information presented constitutes a recommendation by the author or Extrinsiq to buy, sell or hold any security, financial product or instrument discussed therein or to engage in any specific investment strategy. The content, tools and calculations neither are, nor should be construed as, an offer, or a solicitation of an offer, to buy, sell, or hold any securities by the author or Extrinsiq. Neither the author nor Extrinsiq offer or provide any opinion regarding the nature, potential, value, suitability or profitability of any particular investment or investment strategy, and you are fully responsible for any investment decisions you make. Such decisions should be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance and liquidity needs.

      Options involve risk and are not suitable for all investors. Options transactions are complex and carry a high degree of risk. They are intended for sophisticated investors and are not suitable for everyone.

      Table of contents

      Disclaimer

      About Extrinsiq

      About the author

      About the Extrinsiq Advanced Options Trading Guides series

      1. Introduction to option market making

      The theory of market making in general

      The theory of options market making

      Why only out-of-the-money options matter in general

      Why option market makers are primarily trading volatility

      Exercise 1

      2. Making a market in options

      Valuing options : theoretical versus market

      A typical mathematical option valuation model

      How to make a market in an option

      The value of the option or option strategy

      The appropriate width of the bid-ask spread

      Other factors to consider when making a market

      Making a market in options : a summary

      Making a market : imagined examples

      Exercise 2

      3. Options risk management

      The theory of options risk management

      Options market making : the primary risks

      1st order risks

      Higher order risks

      How to mitigate risk

      Delta hedging

      Spreading options

      Simple spreads

      Butterfly spreading

      Time spreading

      Cross-product spreading

      Gamma trading

      Interest rate hedging

      Risk management summary

      Exercise 3

      Solutions to exercises

      Exercise 1

      Exercise 2

      Exercise 3

      About Extrinsiq

      Extrinsiq publishes educational material in the field of finance.

      About the author

      Simon Gleadall is an experienced professional options, futures, equity and fixed income ETF trader, as well as a best-selling finance author. He co-created Volcube, the world’s leading options training technology. He is based in London, England.

      About the Extrinsiq Advanced Options Trading Guides series

      Clear and concise guides that explore more advanced options trading topics. Check out the other volumes in the series...

      Volume I :  Option Gamma Trading

      Volume II :  Option Volatility Trading : Strategies and Risk

      Volume III :  Option Market Making : Part I : An Introduction

      Volume IV :  Trading Implied Volatility : An Introduction

      Volume V : Option Greeks for Traders : Part I : Delta, Vega and Theta

      Volume VI : Losing Money With Options : Advanced Techniques

      1. Introduction to option market making

      The theory of market making in general

      Market making is a business activity that involves offering two-sided prices in a product almost all of the time. The market maker must almost always be prepared to buy or sell the product at prices that he chooses. The market maker aims to make a profit from his activity by buying consistently below the price at which he sells. He hopes that lots of people will sell to him at his bid price and buy from him at his (higher) offer price. In this way he will capture his bid-ask spread (the difference between his bid price and his offer price). This is the market maker's main potential reward from his trading activity.

      The risk to the business of market making is simple to understand. It is the risk that the market maker will be holding inventory whose value moves against him before he can trade out of the position.

      Suppose John decides to make markets in used automobiles. He must be prepared for clients to approach him and ask for a two-sided price. In other words he must be ready to show a price for which he will buy the client's car and also a price at which he will sell a car to the client. Hopefully many clients will walk through the door and buy and sell cars to John, and he will collect the difference between his bid and his offer prices. The primary risk to John is that a continual stream of clients try to sell cars to him and that the general price of used cars subsequently falls. John's inventory will thereby lose value. If losses on the inventory consistently outweigh the profits from turning over (buying and selling) cars, then market making is not a good business to be in. So, no matter what the product (whether it is a financial

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