Option Market Making

<body> <table border="0" cellpadding="5" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="50%" valign="top" rowspan="2" bgcolor="#FFFFFF"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table2"> <tr> <td width="100%" bgcolor="#333366"> <p class="header_yellow" align="center">Contents</td> </tr> <tr> <td width="100%" class="explanatory_text"> <table border="1" cellpadding="0" cellspacing="5" style="border-collapse: collapse" bordercolor="#CCCCFF" bgcolor="#CCCCFF" width="100%" id="table3"> <tr> <td class="contents_expanded"> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>1. Economics of Option Market Making</b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>2. Options</b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">What is an option?</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Option fair value</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Option pricing models</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Volatility</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Financial and futures options</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>3. Option Risks </b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Introduction to option risks</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Delta risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Gamma and lambda risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Theta risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Kappa/vega risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Rho risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Skew risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Time spread risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Extramarket risks</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>4. Position Risk Profiles</b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Basic option positions</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Position risk profiles</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Limited and unlimited risk analysis</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Risk determination</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>5. Synthetic Option Market Making</b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Conversions and reversals</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">The effect of interest rates on synthetic trading</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Box arbitrage</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Pin risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Inefficient market risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>6. Calendar Spread Risk</b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Time delta risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Time kappa/vega risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Limited- and unlimited-time risk</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Time butterflies</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>7. On Strategy</b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Delta neutrality</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Core strategy</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Time spreading</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Broker order flow and open interest analysis</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Trading fences</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Trading high volatility</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Expiration</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>8. Market-Making Tactics</b></p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Making a spread market</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Making a time spread market</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Position delta adjustments</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Gamma trading</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Adjustment of theta/kappa/vega</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Watching the implieds</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Skew risk revisited</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Tracking trading results</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9">Common mistakes</p> <p class="contents_compressed" style="margin-top: 9; margin-bottom: 9"><b>9. Observations from the Floor</b></p> </td> </tr> </table> </td> </tr> </table> </td> <td width="50%" valign="top" class="body"> <p align="left" class="body" style="margin-left: 0; margin-right: 0">Make this the <i>second</i> book you read on options trading. It delivers exactly what it promises, detailing how professional traders make markets in options. If you are new to options trading, read Natenberg (<a href="../titles/natenberg_s_(1994).htm">1994</a>) and trade for 3 to 6 months. Then you will be ready for Baird.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="130" align="left" id="table4"> <tr> <td width="125"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script> </td><td width="5"> </td> </tr> </table> <p align="left" class="body" style="margin-left: 0; margin-right: 0">Opening chapters cover basic concepts, including option pricing, volatility, the Greeks, option spreads, and market making. What I like about these discussions is that they are not a bunch of theory—concepts are presented from a practical trading standpoint. For example, the discussion of the Greeks goes on to assess risks unique to time spreads. The same chapter also describes extramarket risks, such as the risk of clearinghouse suspension. </p> <p align="left" class="body" style="margin-left: 0; margin-right: 0">The rest of the book delves into trading strategies. This is the meat of the book. Chapter 5 eases us into the subject with a discussion of arbitrage—conversions and reversals. Things aren't as simple as we might hope, as the discussions of pin risk and inefficient market risk attest! Chapter 6 is devoted to the management of calendar spread risk. </p> <p align="left" class="body" style="margin-left: 0; margin-right: 0">Chapters 7 and 8 cover how to manage a trading book and how to make options markets. An options market maker's role is not to make speculative bets, especially not on the direction of the underlier. Still, risk is part of the process. Making a market often entails holding a mismatched book. Chapters 7 and 8 clarify what sorts of mismatches are reasonable, and which should be avoided. Liquidity or transaction costs often make dynamic hedging unattractive, so practical spread strategies play an important role. These chapters addresses strategy in various contexts and various trading environments. They are the most important chapters of the book. Every options trader should read them. </p> <p align="left" class="body" style="margin-left: 0; margin-right: 0">Chapter 9 closes with a discussion of career opportunities in options market making, both on exchanges and in the OTC markets.</p> <p align="left" class="body" style="margin-left: 0; margin-right: 0">I highly recommend this book for traders as well as interested financial engineers and risk managers. It offers hands-on insights that aren't available anywhere else.</p> <p align="center" class="body"> </p> </td> </tr> <tr> <td width="50%" valign="bottom" class="body"> <table border="0" cellpadding="5" cellspacing="0" style="border-collapse: collapse" width="100%" bgcolor="#FFFFCC" id="table5"> <tr> <td width="100%" align="left"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script> </td></tr> </table> </td> </tr> </table> </body>