Great blog, I learned a lot from it over the years. The confluence of market making and options is especially interesting.<p>I also used Orc back in the day to trade options, and it's complicated. The thing about options is you have a whole bunch of instruments that are closely related, priced off the same underlying. So there's a smoothness constraint in there that you need to think about (have a google for "non-arbitrage vol surface").<p>Quickie options tutorial: when you trade an option, you have curvature risk. Meaning that when the price moves, the hedge is not some fixed number of contracts. This can be good or bad for you, depending on whether it's concave or convex. On top of that, normally if your gamma is positive (ie you make money either way it goes) you are paying for it by the option losing value (theta is negative). There's a bunch of these greeks, which are just the sensitivities of the option price to various inputs like price, implied volatility, interest rates, etc. Different parts of the surface have different greeks.<p>So it's a bit of a balancing act. A sophisticated MM might decide to hold all their greeks within some range. This would mean slightly skewing your prices in some area of the surface in order to entice someone into trading with you, plus keeping an eye on the underlying.<p>As for market making, it would be nice if prices just stayed the same. People would come and buy things from you for 101 and they would come and sell things to you at 99. You'd just be transporting one order to the other one in time, the perfect middle-man business. The customers win because they don't have to meet each other, and you win because you have 2 more in the account.<p>Sadly that isn't what happens. Sometimes a guy comes by who wants to buy at 101, and then 102, and then 103. The market has moved, and you being such a nice guy have sold at those prices and are now short when the thing is more expensive. This not cool, but the real problem is that you were standing there the whole time offering product while not knowing what it was worth. What's worse is that you're more likely to get deals when this is the case. This is the adverse selection issue: you have a bunch of competitors when things are plain sailing but then when things move you "win" the deals.<p>So, what to do? One thing you can do is just not trade with that guy with the massive orders. Find a bunch of punters who aren't dealing massive orders, and deal in opposite ways to each other. Often what actually happens is some guy who is good at marketing builds a business doing this, and since he doesn't know how to also do the market making, he cuts a deal with a market maker. This is what you might have read about. You split the earnings between the marketing business and the risk business.<p>All of the above is of course helped by being really fast. If you see a bunch of sellers, you pull your bids quickly so they don't sell to you. If you see that you need to move your prices, you do it fast so that you're first on the new price.<p>There's even more to this game in the form of arbitraging other people's orders, but we'll leave that for now.