Scenario: You Sell 1 Put Contract
-
Stock: XYZ
-
Strike Price: $100
-
Premium Received: $3 (so you get $300 since 1 contract = 100 shares)
-
Expiration: 1 month
-
Stock Price at Trade: $100
1. You Sell the Put
-
You’re obligating yourself to buy 100 shares of XYZ at $100 if assigned.
-
You receive $300 premium.
2. Market Maker Buys the Put
-
The market maker is on the other side, so they buy the put for $3.
-
This put has a delta of around -0.40 (just an example — meaning for every $1 drop in XYZ, the put increases by ~$40 in value).
3. Market Maker Hedges Delta
-
The MM now has -40 delta from the put.
-
To hedge, they short 40 shares of XYZ stock.
-
Why? Because shorting stock gives +1 delta per share, so +40 delta offsets -40 delta.
-
Now they’re delta-neutral: not exposed to immediate price moves.
-
4. Stock Moves — Market Maker Adjusts
Let’s say XYZ drops to $97.
-
The put delta might now be -0.60.
-
So now they’re under-hedged: they have 40 short shares but need 60.
-
They short 20 more shares to re-balance.
This is delta-gamma hedging — constantly adjusting based on how delta changes.
5. At Expiration
Let’s say XYZ closes at $95.
-
The put finishes in the money by $5.
-
You, the put seller, have to buy 100 shares at $100 (so you take a $500 hit on the shares).
-
But you got paid $300, so your net loss = $200.
-
The MM exercises the put — they sell you the 100 shares at $100.
-
Since they were short 100 shares already (from hedging), they just deliver those.
-
They close out flat, and profit from the option spread or order flow.
Scenario: Stock Closes at $105 at Expiration
-
You sold a $100 put for $3, remember?
-
The option expires out of the money — it’s worthless.
What Happens to You (Put Seller):
-
You keep the $300 premium.
-
No shares are assigned, no obligation — pure profit.
What Happens to Market Maker:
1. They Bought the Put for $3
-
It expires worthless — they lose the $300 premium.
2. They Hedged by Shorting 40 Shares at $100
-
Now XYZ is at $105, so their short position is losing money.
-
They must buy to cover at $105 — a $5 loss per share:
-
40 shares × $5 = $200 loss on the hedge.
-
3. Net for MM
-
Lost $300 on the option
-
Lost $200 on the hedge
-
Total loss = $500? Not quite — because they adjust the hedge continuously as the stock moves.
-
They likely reduced the hedge as delta shrank (put delta falls as stock rises).
-
So real loss is less, and they might even profit overall depending on spread, fees, and adjustments.
Bottom Line:
-
You profit if the stock closes above the strike.
-
Market maker hedges dynamically — losing on the option but trying to balance it out via delta hedging.
-
MM’s goal is not to win directional bets but to profit from order flow, spreads, and volatility management.
