1) Do option market makers, go after higher volatilty underlying (rewards)......or low volatility underlying (risk)......or is it a combination of both....how is that determined?2) How often do they re-hedge (intra-day, daily, weekly, monthly...I remember in Natenberg, how often you rehedge is not so important because it naturally smooths??)? Rough estimations, based on variable (volatility perhaps)? 3) I know that option transaction costs in the pit (cboe), are like one cent per option contract (exchange cost?)......If they are adding or subtracting delta (to stay neutral), on the stock side of the equation, what kind of transaction cost do they have to pay?4) I assume that all market-makers try to go delta-neutral for the close of the market. But what happens if after the market closes, something happens (news) that causes the underlying to move. How does the neutral market maker, attempt to not get left directional? Thanks....

bump for help!!

short answer...read "option market making" by A.J.Bairdi might go through details later

maybe someone will answer!

Hi Man,Some thoughts from an 'engineer': If you read some threads carefully you could guess who is a practioneer - have a look at things concerning P+L, pricing, risk. One possibility would be to _ask_ for help/information. But they are no lecturers - give your 'partner' a reason why he should spend his time: may be every week his bank comes up with trainees asking the same and 99% he will sent away.Your questions are very general and the answers may depend on markets, on wether you are asking a trader or a MM and also on the individual style. One coming from theory will not answer, a quant either, sales person never and a trader might not be willing to respond on MM questions and there will not be many actively reading MM at the board.To my best knowledge on european equity indices and since nobody else tries ... 1: They first go according to their current book(s) + market and 2nd on their expected market, book and P+L. 2: 'Continously' since as MM they have to act often and the book thus changes (and if you like Taleb: it makes it path dependend). 3: Zero - do never mention cost accounting 4: No. He will be not do any delta brute gambling but rarely he will be flat holding 60 and more positions, he looks at all greeks.

AVt, Thank you for answering! One question though, on #3 transactions costs, you say never speak of them (guess that is a joke). I am really interested in understanding how equity MM lower their transaction costs on the stock side if they decide to sell or add delta using the stock side of the eqation.But honestly, what is the cost of buying/selling stock (per 10,000s of shares, for example), for an established equity MM who makes equity option markets, but does not have their own specialist or market-maker on the NASDAQ or NYSE. Next question is how much does it cost for a corporation like GS that might make the market or specialize in the equity OF the option market they are making? Do they get even deeper discounts?Thank you all!

1. Good marketmakers go after products where there is flow. It's marketmaking, not position trading. Read Wilmott 98 ch 30 if you want to see how market widths get determined. Pretty much all of marketmaking is an extension of the ideas in there..2. Depends on the firm. Most guys cover their deltas as they trade stuff. Some firms have other ways of doing it that I'm not going to talk about. The smart ones don't do it the "other ways". There are loads of articles on discrete hedging. Wilmott 98 covers it in chapter ~22 or so. (goes ~ chisquared)3. Option fees are 0.4 cents per (100 mult). Stock fees depend on who does your stock meets for you. It's negligible. So are the option fees on anything with more than a dime wide market.4. Sometimes you can trade after hours. If you're smart and lucky you won't have to worry because you'll be flat delta over a broad interval of stock price movements. If not, well, that's what you get paid for as a market maker.Read Boyle/Vorst (~86 or so) for the basic idea behind hedging under transaction costs. Honestly the bid/ask fees there are much more relevant than the clearing fees are. Also, it's a highly nonlinear problem (w98 ch24 or so, for starters). Neither situation is worth much attention particularly because practicioners do NOT engage in large amounts of dynamic hedging; typically a trade is tied off with deltas quickly and then you spend most of your time pairing off vol and strike risks. Your book is mostly flattish; static hedging dominates.None of this stuff is even remotely proprietary; I guess the reason nobody wants to answer is because there are probably only about two guys in the entire universe that trade vanilla equity stuff and bother reading quant stuff. Me being one of them (not that this was particularly quantitative, anyways...)

B2 here thinks he's got all the secrets, but they all use water to boil, so to speak.What he refers to as the smart way of doing things.Usually that means building a factor model and then trading the factors against individuals... it's fairly common nowadays and certainly most people are doing it.That means that you would be hedging your vega (or whatever risk factor you decompose into) in one surface with a possible different vega on another surface... or the deltas with some other factor-driven delta (maybe the index).The thing you have to remember that plain vanilla option market making has gotten very efficient, and there is very little edge, so market makers have turned to ever more sophisticated statistical methods and obscure proxy hedging methodologies.We have a huge automated option market making machine which does all this automatically. There is almost no human intervention involved. (It trades around 10,000 trades a day)If B2 is not going to talk about it, I certainly don't mind elucidating it.Regards.

Thanks for the answers.I am wondering about what FDAX said,"That means that you would be hedging your vega (or whatever risk factor you decompose into) in one surface with a possible different vega on another surface... or the deltas with some other factor-driven delta (maybe the index)."FDAX, can you get even more detailed?

i've seen it mentioned before and when i saw it mentioned here again (by filthy) so i finally went to the library and picked it up.man: i can tell you that "Option Market Making" by Baird is going to answer a lot of your questions. i am in a similar situation to yours and this book is helping me *a lot*. i would really recommend that you pick it up, give it a quick read (it goes fast), and then come back with more specific questions. it's definitely not the last word, but it is giving me a foundation to build on. (i think) i finally understand what derivative traders are trying to do on a day to day basis and what they do with all these fair value pricing models, risk models, etc in order to make the money they do and not blow up.good luck.

I am going to the library today (local college) to check it out!

Perhaps the below paper might help you out in a way or another:"Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing," with Mel Jameson, Journal of Finance 47 (1992), 765-780.

Just got back from the library. All they had from Baird, was "Electronic trading masters secrets from the pros."Book costs $75 that I can not afford.

dont know where you are but can't you do an inter-library loan or something?the isbn on the book in my hands is 0-471-57832-0