Hedging the Risk
Delta is the easiest risk for floor traders to eliminate quickly. It becomes
second nature for veteran floor traders to immediately hedge nearly every
trade with the underlying. Remember, these liquidity providers are in the
business of buying option bids and selling option offers, not speculating on
direction.
The next hurdle is to trade out of the option-centric risk. This means that
if the market maker is long gamma, he needs to sell options; if he’s short
gamma, he needs to buy some. Same with theta and vega. Market makers
move their bids and offers to avoid being saddled with too much gamma,
theta, and vega risk. Experienced floor traders are good at managing option
risk by not biting off more than they can chew. They strive to never buy or
sell more options than they can spread off by selling or buying other
options. This breed of trader specializes in trading the spread and managing
risk, not in predicting the future. They’re market makers, not market takers.