Sheridan Options Mentoring Blog

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Trade Execution Like the Pros – Part 3 Posted: 13 Apr 2011 01:12 PM PDT Dan Sheridan is having another follow-up webinar on Saturday, April 16th at 9:00 AM Central (Chicago) Time. This will be the 3rd webinar on trade execution. Trade Execution Like the Pros – Part 3 Sign up for this free webinar here.

How Do Market Makers Hedge or Adjust Trades? Posted: 13 Apr 2011 11:22 AM PDT The world of adjustments for a retail trader can be very daunting . The arsenal of upside adjustments can include an array of possibilities: long calls, call debit spreads, put credit spreads, bullish calendars or butterflies, and long diagonals, just to name a few. On top of that, you have the fun task of deciding which adjustment to use and when to use it. To make matters worse, each adjustment affects the Greeks and margin and the ultimate choice has to be tied into your trading plan. Good luck! This process takes a lot of time and practice I was a Specialist, which is a Market-Maker with much more responsibility. When Goldman Sachs or other brokers came in our pit, they came to the specialist. He was the one they would hold responsible if they didn't get what they want. How did it work? Mr. Goldman might buy 1000 at-the-money calls from me. As the specialist, I could take up to 40% of the order, the market makers would split the rest. My take of the 1000 calls would have been 400 contracts. At-the-money deltas generally would be around 50, so if I sold 400 contracts, I just got short 20,000 deltas! If you’re wrestling with the concept of deltas, just pretend you are short 20,000 shares of stock. Get the idea? How did we hedge our trade? Could I buy calls from traders in my pit? No way, everyone sold Goldman calls, we were all in the same boat! The only logical and quick choice was to call our stock clerks and have them buy stock at the appropriate exchange. We could hedge our deltas and most importantly, take a deep breath because we were closer to delta neutral. That is a concept that sounds very comforting but in reality doesn't address the risk of a position. It just means at that second, at the current price, you are hedged. Conclusion As a professional trader, I would hedge my trade or adjust my deltas first by buying stock. After that, I might spend a few days or hours massaging my Greeks to get them where I want to be, based on my price and volatility expectations. The difference between myself in the pits and retail traders is choice! You can trade when you want to. We had to trade, whether we wanted to or not As a retail trader, buying stock as an adjustment or hedge would be painfully expensive. In a portfolio margin account, it would be much more palatable. In a retail account, instead of buying stock, you could buy deep in-the-money calls with deltas 70 or higher. The more in the money you buy the calls or puts, the less affect you will have on your position gamma, vega and theta. Neutralizing your position with stock or in-the money options is only a good first step. Once the position is stabilized, then you must massage the risk of the position if you aren't comfortable. Lastly, in a fast moving market, adjusting or hedging with single options instead of spreads can sometimes be easier to get executed at a reasonable price.

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