What I learned As A Massive Options Market Maker

I used to be a huge options market maker. I actually made a market in over the counter options on interest rates and foreign exchange. In fact, I may have been the biggest in the world or darn close to it. We will never know because it was all done over the counter. Phone call to phone call.
Every trade was for at least tens of millions of dollars.
I would use the exchange traded options when I wanted to adjust my portfolio or hedge a position. So I traded literally millions of contracts on the various option exchanges.
Most of our business came from other dealers, like JPMorgan or Citibank. We didn’t have too many corporate clients. We never dealt with the public.
Here are the main things I learned as a market maker:
• Who cares what the strike price is at expiration? I’m rarely going to carry a position to term. All I care about is buying the cheapest delta and Vega I can or selling the highest priced delta and Vega. I’ll get out of the position soon enough so all I care about is what will the position do today and tomorrow. I can always adjust the position later.
• The focus on delta is obvious but a market maker also lives in the Land of Vega. Vega is the sensitivity of the price of an option to changes in the implied volatility. In fact, when someone called us for a price, we would trade not the price of the option but the implied volatility of the option. To us, the price was 16-17. Or bid 16% implied volatility and ask 17% implied volatility. To this day, I focus more on the vol than the price of the option.
• Corporate clients weren’t that bright. They would call for a price, we would give it to them and they would take it. Bingo! A nice profit for us. Very rarely did we run across a corporate client who was sharp and understood options. We all know that retail traders don’t know much so I was surprised that so few corporates knew what they were doing. We actually had to protect them!
• Corporate clients are bad at timing markets. Once again, their treasury and finance operations didn’t really know anything about trading so they would hedge when they shouldn’t and didn’t hedge when they should. Not many were any good at calling the markets.
• Economists are idiots. Same thing here. They just seemed to be divorced from reality. Part of the problem is that they had no courage. They were wimps. If they saw that the consensus for non farm payrolls was up 200,000 but they thought it would be up 500,000, they would never announce 500,000 was their prediction. They would wimp out and come in very close to the consensus rather than take a stand. They never wanted to look stupid but their lack of courage made their predictions stupid.
• Central bankers are even dumber than economists. Nuff said.
• The key to trading options is to have an opinion on price direction, price speed, implied vol and how much time left to expiration. Hardly any retail or corporate traders look at all or most of the Greeks before putting on a position.
• Both retail and corporates have a strong bias toward buying options not selling them. I think this also comes down to courage. A bought option comes with a built in stop loss and that is very important to our clients. They always knew what their maximum risk was. We dealers, on the other hand, were therefore always net short options. So we had to understand the various risks on a far deeper level than our clients. I was net short options during the Crash of 1987. by billions of dollars. Which meant I had a terrible position going into the Crash. But I ended up making more that day than any day. We were able to accomplish that because we knew what to do when things went bad.
There are many more things I learned at that job. I got to play with the Big Boys.
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Good option trading,
Courtney Smith