Lesson 2 of 5 · 2 min
Who's on the other side
Option buyers vs sellers, and the market makers who end up holding the other side of most trades.
Every option that's bought was sold by someone. Knowing who that someone is explains a lot of what comes later.
Buyers and sellers
- Option buyers pay the premium. Their loss is limited to it, and their upside can be large.
- Option sellers (also called writers) collect the premium up front. In return they take on the obligation, and their loss can be much bigger than what they collected.
Buyers want a move. Sellers usually want quiet, so time passes and the options lose value.
Market makers, in one paragraph
Most of the time, the person on the other side of your option trade is a market maker (also called a dealer). Their business is quoting a price to buy and a price to sell all day, and earning the small difference. They don't want to bet on direction. So when a dealer ends up short calls because customers bought them, the dealer hedges: it buys or sells the underlying (shares or futures) to cancel out the directional risk. That hedging is real buying and selling, and it's why options can affect the futures you trade.
Hold on to this
"Dealers hedge" is the key idea behind the whole Options Flow track. How much they need to hedge, and in which direction, depends on delta and gamma. That's next.
Quick recap
- Buyers pay premium for limited risk. Sellers collect premium and take bigger risk.
- Dealers usually take the other side and stay neutral by hedging.
- That hedging happens in shares and futures.
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