Secrets of the Option Specialist

Options Trading Topic: Secrets of the Options Specialist

Dear Options Trading FAQ:

Are there any books that describe in detail what an option specialist does? I think having a better model of how the specialists think and behave would help out my wallet. What option books do specialists read to learn how to do their job?

Here are some other things I'm wondering about:

How does the specialist protect himself from option traders who have inside information? What does he do to limit his risk exposure?

Is the specialist for a stock also the specialist for options on that stock, or are they separate?

What else should I be asking about option specialists that I haven't thought of yet?

Ultimately I'd like to be able to develop a computer simulation of the market that includes the operation of the specialists as an integral part.

PS: I realize that I'm asking a lot of questions, but since you're offering such valuable information at such a low price I'd be a fool not to ask! :-)

Option Trader Full of Questions

Dear Inquisitive Option Strategist:

Great questions! First off, call the stock and option exchanges for materials explaining their option specialist systems. Some of the option floors feature different procedures so be sure to ask all around.

Yes, the option specialist is different from the stock specialist Trading for each occurs at different floors. There is some general information on how stock specialists function but little on what goes on with the option specialists. The function of each is similar: to ensure a ready and orderly market in their security, stepping up with bids or offers with their own money if necessary. The reward is making a steady income off the spread differential. The risk is not managing the hedging properly (staying delta neutral) and getting bagged the wrong way with the stock running against you.

Traders with inside information can really sock it to the options specialist. The delta neutral positions can get smacked out of kilter on news induced gap openings from which it is difficult to recover. You ask about books on the subject. I have heard that Jack Schwager's New Market Wizards has an interview dealing with the dangers from traders possessing inside information. Haven't read it myself yet.

There really aren't many books dealing in depth with the subject of options specialists. For most, it remains a black art and the specialists themselves prefer to keep it that way.

Once in a while, some journalist plays up the "unholy" advantage they supposedly have, but the rewards come with great risk. How about the ulcers from the Crash of 87? Specialist assignments go only to the very well capitalized.
On the stock exchanges, the specialist function is a time-honored family affair, with knowledge passed from grandfather to dad to son. The tradition continues today.

The primary concern to the option specialist is how to hedge himself from market movement. The usual goal of the option specialist is to stay neutral. That is, to make money dealing the spread and not to speculate on the direction of the stock. An option order that the specialist fills himself will get hedged by buying or shorting the common stock.

Here is a little known fact: The need to hedge with the common explains why fills can be poor in the 10 minute time frame between the close of the common stock and the close of the equity option markets. If the specialist can't lay off the risk with stock done in the aftermarket, he'll factor in a little extra room in the option spreads.

There is so much to say on this subject that I can't do it any justice. Check the specialty (stock market) book mail order companies for literature on the matter.

Other questions to look into: How do they determine the opening prices? And in time of a panic, or big news? What specialist systems/public order book procedures do the different option exchanges use? How does it exactly work?

What is the role of the market maker on the option floor? What is a DPM (Designated Primary Market Maker) on the CBOE? Why am I asking the questions? Am I not supposed to be answering them?

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Broker, Options Specialist, Options Floor

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