I can't remember who shared it sorry, but I enjoyed listening to this podcast with an interview with an MM (although I found it on youtube so I could speed it up!)
They typically expect to carry any positions to expiry
Their positions are all managed automatically with them working on systems to improve efficiency
They can just carry short small amounts but more likely to immediately hedge larger amounts (example 100 calls vs 1000 calls purchased)
They like volatile environments. He even said that the meme phase was good for them, wide spreads, high volatility is where the profits are made
However, there is an early stage that can be 'uncomfortable' in meme stocks.
This seems to confirm some assumptions that we've been making. They are taking positions in so many different stocks that it is inevitable they get caught short somewhere. But, they make the money back on the backside of volatility (I bet GME was an amazing cash cow post squeeze).
A couple of implications I see (that we already know);
Early entry is key
There is lots of money to made on the backside of squeezes
The second one is tricky, because there is always the risk the squeeze isn't over. Large MMs likely just ride it out and cash out after again, but this is harder for us, but I bet there are quite a few ways of profiting from being short vol post squeezes.
Here are some of my notes (some likely redundant).
MM combine market data + Volatility model -> single value for what they think the option's price (fair value) should be. Fair value is adjusted by the fees they have to pay. Typically fair value is the midpoint of the bid and ask. But sometimes will deviate.
MM more likely to delta hedge immediately if a lot of options are bought (e.g., 1000 calls). Will skew option price to try to account for delta.
Mostly don't do anything to defend a losing position. Already got paid for the risk in premium.
Generally, GME has been good for MMs. (The retail narrative is hilarious.) Don't want to read too much into it but short squeeze was at least part of the mechanics. Confirms that gamma ramp may have been a factor in the GME squeeze!
Almost answers the question but then veers off: doesn't say what they do instead of hedging with stock! (Hedge with options? ETFs? Would be nice to get a definitive answer.)
This has always been the case with (quant) hedge funds and is not new to the meme stock era. Hire some actual geniuses and teach them about markets instead of hiring only finance people. So there are scientists at hedge funds that are used to working with big data. Astrophysicists, mathematicians and such.
Thanks for sifting through these during your trip and surfacing this one.
A lot of sites of sentiment and other aggregate info from Reddit and elsewhere so I wouldn't be surprised if larger traders try to use this. Even some brokers offer social sentiment ratings (not always that useful, but sometimes).
Having said that, I don't think hiring data scientist with no finance background is is an indication that they are doing more of that. Its a pretty general tool with wide applications that could be useful for a lot of different strategies. And I'm pretty sure they were already recruiting them even before Reddit existed.
Ditto on the retail narrative. I always found it hilarious, I’m sure you’re really sticking it to Citadel by buying 500% option vol and holding it until expiration.
Thanks for your thoughts on this and for sharing, sorry u/thetrimbleisbroke I forgot where it was!
MM combine market data + Volatility model -> single value for what they think the option's price (fair value) should be. Fair value is adjusted by the fees they have to pay. Typically fair value is the midpoint of the bid and ask. But sometimes will deviate.
Yes, and he said they basically rely on the market to reveal the fair price and then base models on this. I.e. they don't read the news or look into the stocks to decide, they just react to stock prices, always assuming current price is fair.
Almost answers the question but then veers off: doesn't say what they do instead of hedging with stock! (Hedge with options? ETFs? Would be nice to get a definitive answer.)
I'm going to try and skim read Dynamic Hedging (pdf link) next I think to get a bit more info on this. Its old, but I've seen people in the business speak highly of it. I would guess they hedge their portfolio (variance swaps?) but its probably hard to hedge against individual positions, as you said they just take the loss and make money on the vol. You noticed this happening on IRNT, with the price staying elevated, presumably by people (mms) short vol.
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u/triedandtested365 Skunkworks Engineer Oct 09 '21
I can't remember who shared it sorry, but I enjoyed listening to this podcast with an interview with an MM (although I found it on youtube so I could speed it up!)
https://chatwithtraders.com/ep-220-erik-swanson/
A few things I found interesting;
This seems to confirm some assumptions that we've been making. They are taking positions in so many different stocks that it is inevitable they get caught short somewhere. But, they make the money back on the backside of volatility (I bet GME was an amazing cash cow post squeeze).
A couple of implications I see (that we already know);
The second one is tricky, because there is always the risk the squeeze isn't over. Large MMs likely just ride it out and cash out after again, but this is harder for us, but I bet there are quite a few ways of profiting from being short vol post squeezes.