Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing

Authors

  • MEL JAMESON,

  • WILLIAM WILHELM

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    • Jameson is with the College of Business and Economics, University of Nevada, Las Vegas. Wilhelm is with the Wallace E. Carroll School of Management, Boston College. We are grateful to Chuck Anderson, Larry Benveniste, Tim Mech, Glenn Satty, Bob Taggart, the referees and René Stulz (the editor) for their comments and suggestions.

ABSTRACT

In this paper we provide empirical evidence consistent with the hypothesis that options market makers face risks in managing inventory that are unique to the options markets. In particular, we show that risks associated with the inability to rebalance an option position continuously and uncertainty about the return volatility of the underlying stock each account for a statistically and economically significant proportion of the bid-ask spreads quoted for a sample of Chicago Board Options Exchange options.

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