Market making and risk management in options markets

This article examines the personal trading strategies of member proprietary traders in the natural gas futures options market. Trading activity is found to mirror previous findings in futures markets, specifically high frequency trading, with low risk exposure. The portfolio of risk holdings by member proprietary traders are also examined to identify whether they are instantaneously hedged using the underlying futures market, as well as to investigate how they manage their inventory holding, rebalancing, and volatility risk exposures. Findings of longer-term risk management practices by option markets indicate that instantaneous hedging does not take place in this market. Exposure to price and volatility risks is actively managed, while rebalancing risk exposure has a significant impact on profit for this trading group.