SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

If Our Options Trade Wins, Who is Losing?


My Cabot Options Traders have had some monster winners trading options in 2018, with huge paydays in Cisco (CSCO)—a gain of 565%, Nutanix (NTNX)—a gain of 307%, Union Pacific (UNP)—a gain of 227% and most recently Axon Enterprise (AAXN)—a gain of 175%. It’s been a lot of fun.

But one of my subscribers was wondering recently about who was on the losing end of these trades.

Here was our conversation:

Subscriber: “The Nutanix (NTNX) calls, this person that made the market in this particular instance had to lose a boatload of money! How is that cost covered?”

Me: As a former market maker on the Chicago Board of Options Exchange I can tell you I was theoretically on the wrong end of many trades like this one. However, if I hedged the trade properly, there is a great chance that I would break even, or even make money on a trade like this.

For example, assuming the Cabot subscriber bought 10 calls from me, the market maker, I would instantly hedge the trade. I could do this two ways. The first way is to buy NTNX stock. So if I sold 10 calls (bearish position) I might buy 500 shares (bullish position), which would leave my position net neutral. As the stock shot higher I would lose money on the call sale, but I would make money on the stock position. Or, instead of buying the stock, I might buy 10 other NTNX calls to hedge the position. Because of these hedges trading options, the loss for the market maker on such a call sale is not a forgone conclusion.

Subscriber: “What or who is the market maker, some hedge fund or what? How does that entity make money? I assume they have to make money or there would be no sense in doing this, right?”

Me: For 10 years I was that market maker on the CBOE, it was my job to make markets for you to trade on. In every trade, I was trying to make money on the spread between the bid and ask of an option. For example, if a call was worth $1, my market was $0.90 – $1.10. I would buy it for $0.90 and sell it for $1.10. So I would theoretically make $10 on every contract bought or sold. And I wanted to do this thousands of times a day. Think of me as a casino. I was taking the other side of your betting action, while collecting the “vig.”

Nowadays it’s computers making those markets and trying to collect an edge.

For example, let’s take a look at our AAXN trade: When we bought the call options, the market was $3.80 – $4.10. The option was probably worth $3.95. So when we paid $4.10 we overpaid. The market maker theoretically made $15 per contract we bought from him. So if I bought 100 calls from the market maker, he theoretically made $1,500 on that trade.

When we sold the calls back out for a big profit the market was $11.30 – $11.60. Again, we gave up some edge selling it at $11.30 when it was likely worth $11.45.

Subscriber: “Is there only one Market Maker for all of the brokerage houses?”

Me: To be honest, I don’t know who the market makers are anymore. I’ve been off the trading floor for over five years. However, back in the day there were lots of small trading groups who had market makers on the floor as well as some big firms.

For example, my trading firm was run by two trading floor veterans. They hired me right out of college to learn how to make markets. Once they felt I was ready to trade, they then put $100,000 in my account and took a percentage of my profits as I built up that account. They backed another five traders like myself to make markets. We were considered a small/medium-sized firm. (I would later join a much bigger trading firm to make markets electronically.)

As the years passed, the computers took over, and the markets on trading options tightened. A market that used to be $0.90 – $1.10 became $0.98 – $1.02. My edge in being a market maker was disappearing. And because of that I left the trading floor. This is the case for most market makers. And because of that, when you buy a stock or option you are almost certainly trading with computers from large trading firms.

Jacob is a professional options trader and editor of Cabot Options Trader. He is also the founder of OptionsAce.com, an options mentoring program for novice to experienced traders. Using his proprietary options scans, Jacob creates and manages positions in equities based on risk/reward and volatility expectations. Jacob developed his proprietary risk management system during his years as an options market maker on the Chicago Board of Options Exchange and at a top tier options trading company from 1999 - 2012. You can follow Jacob on TwitterThis article is used here with permission and originally appeared here.

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Subscribe

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Options Strategies for Small Accounts

    Ask a handful of traders what they deem a “small account” to be and you’ll get probably get a few different answers. For the sake of this article, we classify a small account as having less than $5,000. There’s a number of obstacles you run into trading a small account, like the options in certain underlyings being too expensive for you to trade, as one example.

     

    By Pat Crawley,

    • 0 comments
    • 90 views
  • 7 Things I Wish I Knew When I Started Trading

    Options Trading can be very exciting and rewarding. But you should not be trading options before learning at least some basic facts about options. Options are very different from stocks.  This article presents 7 basic options trading facts that every options trader should know. Don't start trading of you don't understand them.

    By Pat Crawley,

    • 0 comments
    • 206 views
  • How LEAPS Differ From Short-Term Options

    LEAPS stands for Long-Term Equity Anticipation Security. Which is just a long-dated option, typically referring to those with expirations more than a year out. There’s no technical difference between LEAPS and shorter-term options other than the expiration date. They’re traded on the same exchanges and have the same rules surrounding margin and whatnot.

    By Pat Crawley,

    • 0 comments
    • 262 views
  • What Is An Implied Volatility Crush

    IV (Implied Volatility) crush when the implied volatility of an option takes a nosedive shortly after the conclusion of a catalyst like an earnings report or corporate action. The uncertainty around a company’s earnings report (or other significant catalyst) drives option prices up in the lead-up to the announcement, and down following the announcement, once the uncertainty is gone.

    By Pat Crawley,

    • 0 comments
    • 210 views
  • Top features of NinjaSpread

    There are two main goals of the scanner: show you hidden opportunities and save a lot of time with automated scanning. Let’s see what the top features are and how NinjaSpread can help your trading life.

    By Gery,

    • 0 comments
    • 763 views
  • Wide, flat SPX Diagonal Spread

    I love to trade SPX diagonals, especially when IV skew is higher than usual and I get a wider range of break evens. I know that time spread break evens are “theoretical” because they are dependent on the IV skew of the front and back month’s IV that changes all the time.

    By Gery,

    • 0 comments
    • 708 views
  • How Investment Trading Can Help Grow Your Business

    When it comes to growing a business, there are many different options out there. For example, you could try traditional marketing methods or explore new and innovative ways of expanding your company. One such way is through investment trading.

    By Kim,

    • 0 comments
    • 1,213 views
  • 3 Tips To Use When Getting Into Asset Management

    Asset management has proven to be a fruitful career for more than a few professionals in recent decades, explaining why it’s attractive to finance professionals and students. Not only is it a financially rewarding career, but it’s one of the more interesting ones to pick.

    By Kim,

    • 0 comments
    • 660 views
  • Extrinsic Value vs. Intrinsic Value

    Options are distinctly different from stocks in that they’re derivatives of another asset. The entire value of an option contract depends on factors outside of itself--it’s all based on the price of its underlying asset. Options are highly mathematical in nature, and in some ways, we can quantify the precise value of an option using a model like Black-Scholes.

     

    By Pat Crawley,

    • 0 comments
    • 771 views
  • Comparing Iron Condor and Iron Butterfly

    Both the Iron Condor and Iron Butterfly are short-volatility option spreads. You'd use them to profit from situations where option prices imply a larger price move than your view of the market. These spreads are how traders profit from stocks that go nowhere.

     

    By Pat Crawley,

    • 0 comments
    • 795 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido