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I understand the market maker is the one quite frequently on the other side of my buy or sell option order (to make sure their is liquidity in the market, and offering the bid / ask spread as "compensation" for what they do). Given that, do these market makers then seek to become "delta-neutral" by owning the underlying security?

As such, does heavy options demand affect the underlying stock / security? Or perhaps heavy options demand can "take care of itself", because now its easier to pair up buyers and sellers without the market maker holding the underlying (assuming they even do).

Please elaborate on any dynamics / considerations you know of here. I'm trying to understand how/if heavy options demand can affect a stock price, say around earnings season or any time options demand becomes heavy.

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You will tend to find as options get closer to expiry (within 2 months of expiry) they tend to be traded more. Also the closer they are to being in the money they more they are traded. So there tends to be more demand for these options than long dated ones that are far out of the money.

When there is this higher demand there is less need for a market maker to step in to assure liquidity, thus there should be no effect on the underlying stock price due to the high demand for options.

I would say that market makers would mainly get involved in providing liquidity for options way out of the money and with long periods until expiry (6+ months), where there is little demand to start with and open interest is usually quite low.

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  • I think you're right Victor. I mean when (option) trades execute within a second, often their isn't a buyer/seller on the other side. But, as long as their is a lot of overall "action", and the market maker can adjust the price of options to meet supply and demand, they should be able to make this work. Eg. on GLD options I've seen ATM call options 3 times as expensive as the ATM PUT options ... rare, but they're obviously setting prices to meet supply and demand, to balance things out.
    – Ray K
    Jan 25, 2012 at 1:58
  • Part of what "bugged me" recently is last Thursday Apple increased substantially on the same day as they released their Thursday weekly options, which many folks were using for trading their earnings today (Tuesday). The following day they equally dropped substantially, and I felt like this may have driven up their share price.
    – Ray K
    Jan 25, 2012 at 2:02
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Option activity can increase volume in the underlying. That increased volume will have little to no effect on price. Read about conversions and reversals.

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