← AdvancedLesson 15 · 3:34
How do market makers and dealers change the picture?
Summary
You can explain how a market maker earns the gap between bid and ask, hedges what it holds, and is short gamma when it sold you an option. You can tell when dealer hedging damps a move and when it amplifies one, and what payment for order flow and Rule 606 reports are.
Key terms
- bid and ask
- The price a market maker will buy at and the higher price it will sell at; the gap between them is its pay.
- dealer
- Any firm that holds options and hedges them, like a market maker.
- short gamma
- The position of someone who sold options, who loses a little whenever the stock moves.
- payment for order flow
- Money some market makers pay brokers for sending them customer orders.
- best execution
- A broker's duty to get a good result for your order, which FINRA says payment for order flow may not get in the way of.
- Rule 606
- An SEC rule under which brokers publish reports on where they send options orders and what they are paid for them.
Check yourself
Answer each question to see why the right answer is right.
1. A market maker quotes the XYZ $100 call at $3.40 bid and $3.50 ask. It buys one from a seller and later sells one to a buyer. What does it keep?
2. The market maker sold you a call with a delta of 52 and bought 52 shares to hedge. A $1 move either way costs it $2. Why?
3. A dealer that bought options hedges as XYZ moves. What do its trades do?
4. A dealer that sold options hedges as XYZ moves. What do its trades do?
5. Some market makers pay brokers for sending them orders. What do the rules say?
Finished the video and the quiz? .