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eyx parent
Market makers are not only motivated by commissions.

Before making a price they will consider multiple factors, liquidity (of the underlying and the derivative) is an extremely important one. They likely will not carry a trade that is impossible to hedge (because the underlying is not liquid enough).

hgibbs
The reason not to trade something that cannot be hedged is because it is impossible to replicate. Of course if the future cash flows of the security are known in advance this point is moot, but for options the idea is that you can replicate the option position by holding a dynamic hedge (this is basically what the black-scholes pde says).
eyx OP
That's the theory, it's not my point.

My point is that a market maker will not carry an option position that is impossible to hedge due to the underlying liquidity. In other words, he will not carry a gamma position that is not "in line" with the liquidity of the underlying.

I may be wrong, but the article is about buying a lot of short dated (high gamma) call options from a market maker and hoping that he will drive the market up while hedging his position.

beezle
In effect, a game of chicken ;)
perl4ever
My impression is that most options are very illiquid, and I've gotten discouraged by the huge spreads. A few things have liquid options, but not interesting stuff. Just trying to buy and sell at the best available price seems very difficult when I see for example a bid/ask of $0/$5.
beezle
Couple things - most options trade a spread of 1-3% depending on how far from the money they are and how near expiration. Option interest also follows interest in the underlying.

In a less traded issue - I guaranty the real price is not $0/$5, it is just nobody has bothered to show interest yet (and sometimes brokers do not provide the true market). Assuming you have a reasonable idea of where the bid should be, low ball it a little and put an order in. Like magic, you'll be joined by a few hundred contracts and in fact, probably out bid. An offer may also appear too.

zeptonix
What are you trying to trade that has a bid of (near) $0 and ask of $5? Most stocks are generally way more liquid. Also you'll find you can get hit at/near the midpoint even when the bid/ask spread is large. (Which makes sense ... as long as you offer a price slightly worse than what the theoretical pricing model dictates ... why wouldn't the market makers want to trade against you?)
benmanns
OTM, non penny program symbols is my guess.
benmanns
Get closer to in the money. Also look up the penny program symbols. SPY is frequently a penny wide spread ($1 per contract).
totalZero
A smart market maker will take the illiquid trade and charge astronomical amounts of bid/offer to compensate for his added risk. There's money to be made in large, chunky, dangerous positions. That's one of the advantages of a major investment bank; they can weather a few storms, profit handsomely on the positions that go in their favor, and net it all out as one profitable business unit.

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