Two essays on option market microstructure

In this dissertation I first evaluate the institution details of competitive market maker behavior in the natural gas futures options and futures markets in order to determine the characteristics of traders subsuming the market making role in these markets. I also decompose option portfolio risk for options market makers by evaluating their intraday and end of day risk holdings. The premise that market makers in futures options markets strategically manage their exposure to volatility (vega) while using futures to offset exposure to changes in the underlying price (delta) is examined. In my second essay, I evaluate price discovery in the futures and futures options natural gas markets using a transaction based approach that uses both the buy and sell prices under the Hasbrouck information share methodology. The model incorporates the implied volatility of option prices using a binomial pricing model to compute an implied futures price from a set of option prices using a two-stage estimation procedure. I also investigate the impact of moneyness and option type on informed trading.