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Market Maker option's pricing with reference spot

When a option’s market maker receives a quote from a broker, usually the underlying spot prices is locked with a reference.

Let’s suppose the following example:

Broker: "Buy 10k call 2800 of ABC Index for August. Ref: 2670"

How the market maker is suppose to quote this option?

I believe that this is to simplify the client/broker to see what is the best quote he has, then trade the cheapest one; but the price from the market maker is really the price that will be traded or something would be adjusted?

Quantitative Finance Asked by DUM03 on September 18, 2020

1 Answers

One Answer

It is just whatever the option is worth assuming the underlying is currently trading at the reference rate and assuming the option carries the amount of deltas the brokers says it has. Usually there is some negotiating on what the fair delta is - since different people use different models/assumptions and have different deltas. If the delta is different from what you have, you just manually adjust for it by (current price - reference price) * number of residual deltas. This adjustment is added to the "fair value" of the option you are looking to quote.

So you price up the option (changing the underlying price to the reference rate), adjust that price by any residual deltas, and you quote around that price.

The reason they quote it tied up is they don't want to have to constantly ask you to re-price the option every time the underlying moves. It also makes a market maker's life easy because they don't have to immediately go into the market and hedge the delta on their own. It could also make the other side's life easy if they are looking to trade vol itself, and not the underlying.

May I ask what market you are looking at?

Answered by confused on September 18, 2020

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