Options Trading: What an Option Is and Who's on the Other Side of the Contract

This is the first article in the guide. It assumes no prior knowledge of options. If you already know Delta and Gamma, skip ahead to the next article.

Who this is for

This mechanism applies to any index, future, or stock you trade, as long as it has a liquid options market.

The numeric examples in this guide use illustrative figures on "the underlying," without pinning to any particular symbol: the mechanism is the same regardless of the asset.

What an option actually is

An option is a contract. It gives the buyer the right, not the obligation, to buy or sell an asset at a price fixed in advance, before a set date.

Key idea: buying an option isn't betting against "the market" in the abstract. You're entering a contract with a specific counterparty.

The question almost nobody asks

When you buy an option, someone sold it to you. Most of the time, that someone isn't another retail trader: it's a firm that makes markets in options professionally: a dealer or market maker. Firms like Citadel Securities, Susquehanna, Optiver, Jane Street, and IMC handle a large share of the options volume traded every day in the US.

This matters because that counterparty's behavior isn't random. It's the core idea behind this entire method:

Key idea: market makers usually don't want to bet on market direction. Their business is capturing the spread and providing liquidity, not speculating on direction.

If you and other traders buy a lot of calls from a dealer, that dealer ends up on the other side: they sold those calls, so if the market rallies hard, they lose money on that position unless they hedge. Since they don't want directional exposure, they hedge: they buy or sell the underlying asset to neutralize that risk. That's called Delta Hedging.

flowchart LR
    A[Trader buys a Call] --> B[Dealer sells the Call]
    B --> C[Dealer is exposed<br/>if price rises]
    C --> D[Dealer hedges:<br/>Delta Hedging]
    D --> E[Dealer buys the<br/>underlying / future]
    E --> F[That buying adds<br/>real pressure to price]

That hedging activity, repeated across thousands of contracts and strikes, is what ends up moving the market's price.

Why this matters to a trader

The intensity of that hedging isn't constant: it changes depending on how much the price moves and how close it gets to strikes with heavy open interest. The measure that describes how fast that hedging need changes is called Gamma, and it's the core piece of this method: it determines whether the dealer's hedging brakes the price move or accelerates it.

The full breakdown of Gamma comes later in this guide. First, we need Delta (an option's basic directional sensitivity), since Gamma is defined in terms of it.

Note on formulas: this article is introductory and conceptual, it doesn't have a quantitative formula of its own. The guide's first formula appears in the next article (Delta).

A concrete example

A large group of traders buys calls concentrated at a specific strike, betting the underlying will rise. The dealer who sold them those calls ends up short calls: if the underlying rallies, they lose money on that position unless they hedge.

To neutralize that risk, they buy the underlying as the price climbs toward that strike. That hedging activity, combined with every other dealer hedging similar positions, adds real buying pressure to the market: pressure that doesn't come from a trader betting the market will rise, but from the hedging mechanics of whoever sold the options.

Example: this same mechanism applies to any asset with a liquid options market. The asset changes, the mechanism doesn't.

Next step

To understand exactly how the dealer hedges, and how much they buy or sell for every point the price moves, the next concept is Delta.

Continue with: Delta Explained: The Directional Sensitivity of an Option