I'm not sure this is such a good idea.
Professional companies that do equity options market making have major natural advantages over you:
- They are at the front of the line of any order if they're on the NBBO, so they're going to capture the spread
- They get order flow from offline brokers, which tends to be high volume and have higher edge
- They do gobs of volume every day and hope to make a fraction of a penny per transaction.
- A typical market maker makes markets in 500+ stocks at any one time. Good luck doing that on your own.
- They've invested in being as physically close to the actual exchanges as possible so that they can be first to respond
- They're rarely greeks neutral beyond delta
- As registered market makers, they have tax advantages you do not
Market makers do this as a free way to cover delta risk in that direction. If you have +100 delta, selling 100 "units" (way out of the money options) is a nice way and doesn't carry any other greeks.
I've seen speculators do this, but they're playing with fire. I've seen an investor risk 9 digits to pick up $50k a minute before strike expiration, not realizing that the actual settlement is the next day (so adversarial events can still happen).
These tail risks are impossible to predict, and volatility of volatility of these events is incredibly high. So your expected value is better to think of as a "very broad range with a positive mean" - are you comfortable with this?
... generally that refers to the strategy of writing (far) OTM options.
Like: the Dow is currently trading at about $49.44; and the bid/ask on a Nov 18th put with a strike of $40.00 last traded at $0.04. So you can write 25,000 of those and get $1,000 in premium. Those are the pennies.
You can't lose any money unless the Dow actually below $40.00 because those options will expire worthless. However, if the Dow goes to $39.00 ... then you'll be on the hook for $25,000. That's the steamroller.
[0] section III of https://www.sec.gov/investor/pubs/regsho.htm
National Best Bid and Offer (NBBO)
There are also specialist market maker roles for specific products, which don't have to use these systems, but those are professionals in niche markets too illiquid for the big shops.
(this rule applies well to a lot of professions, not just high finance)
It takes seeing how some of the second-order effects matter in order to get an inkling of just how much you don't know.
As an approximate programming example, imagine the difference in productivity between a programmer coming out of high school and someone with a couple decades experience with access to version-control, profilers, documentation, a clear understanding of best-practices, who works on a team of five people who will all do the same job, and has access to $1M in AWS credits.
Can the young programmer compete? In principle. Can they deliver on time, every time, for their clients without making a gaffe like the team of programmers can? Probably not.
The goal of a market maker is to trade as much as possible, on either side of the book, with the widest possible spread that remains competitive, while keeping within risk limits.
Most retail option strategies are based on beliefs about the behaviors of the underlying. Like, I think this stock is going to go up, so I'm going to trade a strategy that makes money when that happens (probably with some leverage, and hopefully with some downside protection).
They're not thinking about smile and calibrating stochastic volatility models and looking at their cross gamma and trading OTC exotics to lay-off their risk.
One strategy depends on discipline, scale, operational excellence, deep quantitative analysis and risk management. The other depends on clairvoyance.
does a lot of the "technical analysis" (support/resistance, moving average crossover, volume/volume weighted average price, etc.) become a self-fulfilling prophecy?
there are other members that make up the market + its daily volume other than market makers. i agree, it isn't (or at least shouldn't be seen as) market makers vs retail traders. market makers don't care about direction from what i understand.
it's the high frequency trading hedge funds/funds running algorithms against institutional "whale" investors versus... i'm not even sure i can pretend to understand all of the participants that trade shares (or options) daily/weekly/monthly/quarterly.
there's a portion of psychology manipulation to it as well, right? "oh my gosh, this is going up but it might be a bull trap" aka... some people believe there are entities/an entity behind the scenes driving the price up to "suck people in", and vice versa (bear trap).
The market makers and other participants are not playing the same game, but they are playing in the same market; and that is ultimately zero-sum. If the market makers are making money on your transaction costs, and they're profitable (which they are) then there's already some signal there, surely?
There are already a lot of real professional trading desks doing this. How can you compete with them?
For illustration purposes, imagine you own shares of a ticker that trades around $150/share, with a bid-ask gap of $1. So the lowest sell order is sitting at $150.50, and the highest buy order is sitting at $149.50.
Now, imagine you queue in your way out limit sell order at $200, and then some unsophisticated trader submits their limit buy order at $201. Your limit sell won't trigger, until the entire queue of sell orders sorted by increasing prices (starting at $150.50) gets filled first. If that unsophisticated trader wanted just one share, they will get that one share at $150.50.
The whole idea of a limit buy order at $201 is that it will execute at the cheapest available price, as long as it is below $201. Similarly with limit sell orders, your $200 limit sell will execute only at the edge of bid-ask gap price, as long as the cheapest available ask is at $200 and meets the bid at that number. Until that moment, for every buyer, the queue will be processing all the cheaper ask prices first, until it chews through all of them (which would pump the stock enough to reach your limit sell price).
If you are an unsophisticated maker, you have to quote wider, and yes you will probably get hit very very rarely. But occasionally someone comes through and just needs to unload something as quick as possible, and they will put in a market order to basically take the whole one side of the book and trade down to your level.
Obviously not super profitable, but not losing either! If I knew an easy way to make markets as a retail trader and be wildly successful, I wouldn't blab about it ;)
Is there any wiggle room in that statement for the alternative? If retail options traders come out ahead winning overall 15% of the time... is that worth pouring time into? It becomes a personal decision on whether you should risk your resources/time given those odds.
The question I have is... why do some people win and some people lose? It can't just be luck.
Even the absolute rock star traders have a nasty habit of regressing to the mean on a long enough time line.
It just turns out that when you have a several million participants - some of them have "a long enough time line" of 30+ years.
...well, luck or insider trading.
Given this, you can see why there are just actual purely statistical reasons for tons of trades going well with zero insider trading needed for that. Half of them are bound to do well. Whether you can consistently stay on the "good side" of your trades is a separate story, though.
P.S. Not trying to deny that insider trading exists, but its prevalency tends to be extremely overblown.