What’s Dealer Inventory Got to Do with It?

Andrew Giovinazzi

Yo Pit Crazies,

Tina Turner recently passed away in her Swiss Mansion after what appeared to be a full and exciting life. She famously asked in 1984 (yes I am that old), “What’s love got to do with it?” Well, quite a lot from the sounds of the song.

Dealer Inventory is the options that traders have on their books. If anyone had an interest in option pricing they might wonder, “What’s dealer inventory got to do with it?” Quite a lot would be the answer!

Bill Griffo has created a whole product out of dealer inventory in Win the Week.

I’ve based my retail trading strategy on dealer inventory in part. Why?

The dealers set the price. Investors supply the demand. The market supplies the move.

Why did I circle this sigma number in International Business Machines Corp (Ticker: IBM)?

Because I knew what the dealers were thinking.

Per Month Pricing is One of the Best Pricing Guides in Options

Option Liquidity Providers take the other side of most volume traded on exchanges. That role causes them to take large, illiquid positions for a long period of time. Once they’re in, the retail paper has to take them out or they hold it to expiration. So if they don’t need something, they price it cheap.

Why? Because most of the time, dealers buy options that the public sells. And that makes them cheap.

When I bought a Jul14 strangle (call and put) in IBM for the Easy Button, I found the lowest price cycle for a 5 day hold. For me, that’s about 3 weeks to expiration, the sweet spot between decay and movement.

I only needed IBM, a $130 stock, to move $1 on two consecutive days for me to make money. The chart below shows that IBM was moving on a 17.4% realized vol on average for the last 30 days. That’s over $1.50 per day close to close.

IBM 30 day realized vol on the bottom chart

I got a move 2 days after I posted the trade, and I even got a down move the first day so I could sell some of the puts I owned. I ended up with a 25% return on the trade and hit bricks.

Back to Sigma

Sigma is the average implied vol for the term. Dealers are happy to sell it to me because it gets them out of their inventory. I had to pay close to the offer to get it, and they likely bought it cheaper. The customer that sold it to them was probably a buy writer looking for short term yield against the stock.

If you want to learn to trade based on market fundamentals like I just described, join the Easy Button now.