I'm a programmer and recent trading enthusiast. To learn more about options I'm building a market maker trading bot. So far it gets market prices and volatility and calculates the Black&Scholes. I figured that if my calculated B&S lies between the current market bid and ask, the bot should be able to find an acceptable price to post to the market. From this point on the bot could simply post a bid slightly higher than the current market bid, and an ask slightly lower than the current market ask. When the other market makers then see that their prices are beaten by a newcomer (me), I would assume them to rally against me for both the bid and the ask, resulting in a decreasing spread.
So I'm now at a point where I would need to program a rule so that my bot can decide when to stop rallying with the other bots. In other words; my bot should be able to decide what spread around the calculated B&S value it would still find acceptable.
This gives me the idea that there should be some kind of theoretical model, or at least a rule of thumb, to decide on the acceptable spread for the options that my bot is making the market for. I of course understand that it depends on your risk appetite, but I guess it also depends on the transaction costs, hedging possibilities, volatility and market liquidity. So I hope there is some model or guiding principle to tell me what is acceptable.
Does anybody know any theoretical model or rule of thumb to calculate acceptable spreads for options? All tips are welcome!