I assume the moron in question was using Black-Scholes or some similar formula to price those options, and refused to update their prior when they lost money day after day. This happens quite a bit in derivatives markets.

Black-Scholes is rarely used to actually price options. It's most commonly used to back out what the current implied volatility is.

Things like Black-Scholes (using past volatility of the underlying to model the probability distribution in the future) are often used by market makers to price options, but the vanilla version never is.

Any market maker pricing options with Black-Scholes won't be a market maker for long.

Black-Scholes is just a customer-facing description of the option (i.e, it provides greeks that everyone can understand). But it isn't used as a starting point.

In practice, MM will back out what the implied volatility is from current prices. Then a stochastic volatility model is calibrated against that.

https://en.wikipedia.org/wiki/Stochastic_volatility

No - no market maker is using stochastic volatility. (L)SV is only used for exotics. Market makers use a tricked out Black Scholes where the 'secret sauce' is in how you apply the chain rule when you calculate the greeks.

Would be curious to know more about this.

But why would they refuse to? They're there to make money too, after all.

Maybe they have buddies at SEBI who can freeze their counterparty's assets and return the half-billion dollars they lost back to them.

That's not really how it works, the market making firms would essentially have to update their vol curves in response to that signal (BS being essentially just a coordinate change from price to volatility).

> and refused to update their prior when they lost money day after day

The market takes money from people with incorrect beliefs about economics and gives it to people with correct beliefs. ~~What is the problem here?~~

On second read, I think the parent was just intending a factual statement, which I am willing to agree with.

The market takes money like a bully most of the time. Any other belief is as theoretical as communism vs practice.

If you're selling millions of dollars of options you're taking an extremely willing risk, not getting bullied.

Edit: Reading more about this, it looks like the counterparty is often a bunch of retail investors doing quick trades hoping the stock swings one way or the other, and that's not bullying that's gambling.

I agree with your edited point, and in response to sentiments I saw earlier in the thread—even gamblers deserve nominal assurances against cheating. My two cents, which I personally will be investing in wishes via my local wishing well, to which I’ve connected a dedicated fiber link to power my high-frequency algorithmic wish arbitrage desk.

Disassociates the value of the underlying assets which devalues the currency. Probably why regulatory bodies had to get involved.

it's not the 90s anymore

Black-Scholes takes a couple of parameters. To get hold of them, in particular volatility, requires you to look at what the markets have been doing.

Yeah that seems like it should push the premium higher. Even if it's some institution with very bad quantitative models eventually the careless put writers should run out of shares/capital to secure the puts with and get liquidated.

Presumably retail options traders and less sophisticated firms

Yeah, I think volatility in the indian market was way too low, and Jane street just juiced it. normally that would be a losing proposition, but too many existing players were short volatility habitually… answer is not to kick Jane street out, but to enjoy the taxes Jane street pays on the gains…

Low volatility is good for everyone engaged in long term asset management. Jane Street just found a way to make everyone else less money while making a small amount for themselves.

> Low volatility is good for everyone engaged in long term asset management.

According to who?

There are plenty of pension funds nowdays that have people specialized in picking up mid sized companies after big drops.

it’s a known effect. Without going into details here, you can calculate first crossing time of a barrier in a stochastic process and observe that often the first crossing time decreases as the volatility increases. From there you can set one barrier at 0 (default) and draw your own conclusion.

I'm reminded of how the UK financial regulator banned "binary options" trading, since this was nearly always a scam run against unsophisticated retail investors who wanted to gamble and lost the majority of their "investment".

(one of the Yes Minister irregular verbs: I am providing liquidity to the market, you are long vega, he is a degenerate gambler)

Retail

    > what moron

In India, it is clearly retail investors in the recent retail derivs boom.

I think the point is that retail investors were selling the puts, they predictably sold every day (or more likely, they predictably bought calls which is almost equivalent), and there were no other sophisticated market makers in the market.

That changes the description of part 2 to "subsequently experience retail investors placing large options trades with them" which is much more defensible market making behaviour - their early buying was in anticipation of later demand and really did involve taking a risk.

The truth is probably somewhere in between.

To add to this, that behaviour would typically be OK in the US, with a good compliance department to keep you away from the worst of the grey areas.

If the SEC did investigate you for this, an important part of the case would turn on the extent to which your actions were "bona fide market making". And the regulator would also be more introspective about the market structure that allowed this to happen - why is there only one market maker? How did we allow a derivatives market much more liquid than the underlying?

Huh? I don't think the SEC would (just) apologize for letting you get away with manipulation of a significant portion of the US index funds just because they should have noticed you sooner.

People buy puts for coverage. It's not strictly a speculative tool.

Have you considered that in US markets market makers sell the puts and simultaneously short approximate number of shares to hedge?