Managing the options market involves a variety of microstructural, pricing, and economic concepts. It involves managing a large book of financial assets, adjusting the theoretical valuations of options, and solving high dimensional problems. For example, if the market maker is long the Dec 50 call and the stock’s volatility is low, the market maker might choose to sell the stock short in order to reduce the risk associated with the long position. It also involves managing long-dated options and short-dated options.
The SEC recently amended its rules to allow options market makers to sell stocks short for market making purposes. The rules also allow the options market maker to sell stocks short for hedging purposes. But the SEC cautioned against the practice of selling short while holding new positions. The amendment is likely to have a negative impact on the liquidity in the options market, which is one of the most complex markets in the world.
An options market maker is a person or company that controls the positions of thousands of financial assets. Managing these positions involves pricing, microstructural modeling, and managing short-dated options. A market maker also needs to implement a factorial stochastic volatility model on the underlying asset in order to optimize market making. This can be done using classical finite difference schemes or a simple analytical approximation. Using a simple analytical approximation offers higher flexibility than existing algorithms.
An options market making must have an active market for all options. He or she must compete with other electronic market makers and must maintain a two-sided market. This requires the electronic market maker to post liquidity in options series and make markets for contracts entered into the system. An electronic market maker also must honor orders attributed to the market maker. An electronic market maker must meet legal quote width requirements.
A taker-maker model focuses on attracting high speed traders charging a fee per contract to post liquidity and pay the trader if he or she removes liquidity. The taker-maker model also pays the trader if he or she posts a limit order. An example is a trader who raises the Dec 50 call a few points and then lowers it a few points. This model has been adopted several exchanges to attract big trades.
An options market maker might also make the claim that the best bid is the cheapest price. The best bid must have a minimum number of contracts. This is known as the callask_putbid_threshold and is calculated based on historical price data. The callask_putbid_threshold will vary depending on the market conditions at any given time. The callask_putbid_threshold is probably the most important feature of the make-take model. It also provides the smallest number of contracts required for a successful bid.
An option market maker might also make the claim that the most important feature of the make-take-model is its price improvement mechanisms. These are auctions which have been launched several exchanges to improve prices.