Interesting Article About Hedge Funds Invading the Options Markets

[athos]

Hedge Funds Invade the Options Markets

Just came across this and thought it was interesting. Seems that hedge funds are busting into the options markets, but not in the way that you might think. Instead of just taking down massive positions, these funds are now breaking into options market making on a frightening level.

Do you want to rely on a hedge fund to take the other side of your options trades? Do you want to rely on them to sell you puts when the market is crashing? Don't know about you, but that makes me uneasy.....

 

[A Dashing Blade]

. .
Do you want to rely on a hedge fund to take the other side of your options trades? Do you want to rely on them to sell you puts when the market is crashing? Don't know about you, but that makes me uneasy.....

That's what the clearing house is for!
Exchange traded options for the private punter dealing through a registered company have no counterparty risk.

 

[grantx]

Athos,

There is nothing strange about hedge funds becoming option market-makers. Indeed, by their structures and operations they are two separate entities - no way does one compromise the other. And, as is stated in the article, they increase liquidity and competition, which should be beneficial to end-users.

I'd be more worried about operators like Dashing Blade, personally.

Grant.

 

[Glenn]

About 18 months ago the premiums on the Ftse 100 FOTM options started to fall. This has been due to some extent to Hedge Funds Writing options and thereby bringing volume competition into the 'Insurance' market.
A friend of mine used to regularly write 1000 point strangles for around 11p each leg (30 contracts) but now that the premiums have fallen, most of the time the risk is a lot higher to get the same reward.
Glenn

 

[grantx]

Glenn,

I suppose the logical development would be an decrease in premiums across the board representing, as your friend discovered, less opportunity for selling. This isn’t necessarily a bad thing – simply switch to buying low volatility.

One may argue the relatively high implieds are the result of participants (mm’s) pricing options to provide a minimum return on their operation. If this is, hypothetically, 10% then it shouldn’t be a surprise that someone would be happy with 7%, especially if returns from their other operations (eg hedge funds) are under-performing.

Maybe Profittaker could provide figures for comparison to see if this has endured.

Grant.

 

[fildi101]

I've been trading options for a couple of years, and to be honest I'd always assumed hedgefunds were the main players anyway!

As an option seller myself, I don't really see it as a bad thing. yes, premiums might reduce slightly, but then again there will be more money at work trying to keep the price of the underlying within with the range of the short puts/calls.. so my trades have more chance of winning.. I guess?

 

[Profitaker]

Grant

Figures for what sort of comparison ?

 

[Profitaker]

yes, premiums might reduce slightly, but then again there will be more money at work trying to keep the price of the underlying within with the range of the short puts/calls.. so my trades have more chance of winning.. I guess?

The max pain theory is a fallacy, IMHO. Why ? Because for every short option player there is a long option player. Which means that there is just as much money that has a vested interest in moving the underlying toward the strike, as there is money having a vested interest in moving the underlying away from the strike.

 

[fildi101]

Profitaker,

I wasn't refering to max pain really, but yes, I see your point. I guess time will tell.. the market's always evolving anyway..

 

[grantx]

Profittaker,

Figs for current iv (excluding the big jumps of late) with iv's of 18 months ago.

Grant.

 

[Glenn]

Profittaker,

Figs for current iv (excluding the big jumps of late) with iv's of 18 months ago.

Grant.

Grant
18 months was an approximation to when he stopped doing strangles. Best go back further if you want a comparison.

Re your earlier points, agree with the first except that friend prefers to keep away from the market rather than engage it. To buy on low volty is good - but only if you get direction right.

May have missed your second point. Surely the MM's return is solely a function of the spread and volume. They have to provide a balanced market and end up with balanced books, otherwise they end up with no counterparties to offload onto.
Sure they will move the premiums a little if you pressure them because that brings more volume to their books, but only if they believe they will have a counterparty. This is my understanding although I'm no expert.

Glenn

 

[Profitaker]

Grant

I don't have daily IV figures for the ESX. Unfortunately LIFFE is one of the few exchanges that doesn't quote an option volatility index. But you could use the VIX as a good proxy, or the v.v.dax or cac equivalent.

 

[athos]

Hedge Funds & Options

Clearing houses are for eliminating counter-party risk. However, that is not what I was referring to.

Clearing houses won't help you if the market maker refuses to make a market when the market is crashing, or makes their market so wide that you can drive a truck through it. I've seen this happen a few times before, so I'm always leery when confronted with a liquidity provider with an agenda.

On a similar note, here's another question: Where are all the other hedge funds? Why aren't they in the options market making game? If this is so lucrative, why aren't they joining the party?

 

[grantx]

GJ,

Re ax sheets. In effect, the bank is showing its hand. But why would it do this? OK, customers may be interested, but so would competitors, surely. Or is it a case of the bank getting in (and out) ahead of customers. But they wouldn't do this would they?

Grant.

 

[A Dashing Blade]

You can rest assured that the internal salesforce has had the ax sheet in front of them for a couple of days. These are often sent out as bloomberg emails which can be marked "Non Forwardable" so that they don't leak.

 

[grantx]

GJ,

Not "phoning the last guy to buy me a beer after work."

That will save me a few quid, then.

I'm sure compliance is a proxy ethics code for those found lacking. What, me?

Grant.

 

[charliechan]

About 18 months ago the premiums on the Ftse 100 FOTM options started to fall. This has been due to some extent to Hedge Funds Writing options and thereby bringing volume competition into the 'Insurance' market.
...
Glenn

you sure it wasnt socrates?