Who Are Market Makers?
Large banks and brokerages like Goldman Sachs, JP Morgan, Barclays Bank and so on are the kinds of companies that make up the majority in this business today. The trading platform usually comes with free charting software and news feeds. At each strike price each row in the table information for the Call option to buy IBM is listed on the left and information for the Put option to sell IBM is listed on the right.
Who are market makers in options trading, what do they do and how do they make their money?
Usually, spreads are kept fairly reasonable as a result of the stiff competition between numerous market makers. As counterparties, many of them will then try to hedge , or cover your order by passing it on to someone else. There are also times in which market makers may decide to hold your order and trade against you.
There are two main types of market makers: Retail market makers are usually companies dedicated to offering retail forex trading services to individual traders. ECN-type brokers also serve as counterparties to forex transactions, but they operate on a settlement, rather than pricing basis. Unlike fixed spreads, which are offered by some market makers, spreads of currency pairs vary on ECNs, depending on the pair's trading activities.
Electronic networks make money by charging customers a fixed commission for each transaction. Authentic ECNs do not play any role in making or setting prices, therefore, the risks of price manipulation are reduced for retail traders. Just like with market makers, there are also two main types of ECNs: The type of broker that you use can significantly impact your trading performance.
If a broker does not execute your trades in a timely fashion at the price you want, what could have been a good trading opportunity can quickly turn into an unexpected loss; therefore, it is important that you carefully weigh the pros and cons of each broker before deciding which one to trade through. How Market Makers Work Market makers "make" or set both the bid and the ask prices on their systems and display them publicly on their quote screens.
The trading platform usually comes with free charting software and news feeds. Some of them have more user-friendly trading platforms. The basic role of market makers in the options exchanges is to ensure that the markets run smoothly by enabling traders to buy and sell options even if there are no public orders to match the required trade.
They do this by maintaining large and diverse portfolios of a wide range of different options contracts. For example, if a trader wanted to buy specific options contracts but there was no-one else at that time selling those contracts, then a market maker would sell the options from their own portfolio, or reserve, to facilitate the transaction.
Likewise, if a trader wanted to sell specific contracts but there was no public buyer, then a market maker could execute the transaction by buying those contracts and adding them to their portfolio. Market makers basically make sure that there is both depth and liquidity in the options exchanges. In their absence, there would be significantly less transactions carried out and it would be much harder to buy and sell options.
There would also be less options in the way of different contracts available in the market. Enabling traders to execute transactions quickly, even if there is no willing buyer or seller, in turn ensures that the exchanges operate efficiently and traders can usually buy and sell the options they wish to. As we have mentioned, market makers keep their own portfolios that consist of a large number of different options contracts.
They trade in large volumes and are able to buy options from traders wishing to sell and sell them to traders wishing to buy. Without the makers, the market could easily stagnate and options trading would become significantly more difficult. In return for the important role they play in options trading, they have a major privilege within the market place which enables them to basically make some form of profit on each and every transaction they make due to the way options are priced. There are two main aspects to the price of options that any options trader should understand.
At each strike price each row in the table information for the Call option to buy IBM is listed on the left and information for the Put option to sell IBM is listed on the right.
For each individual Call or Put option, the Bid column shows the level of the highest limit order to buy that exists at that time for that option consolidated from worldwide data by OPRA. This quote might be from one of the market makers for IBM options.
It might also be from some other institutional trader or even a retail trader like us. Notice that we see a fully populated matrix here, with no holes. Every option has both a Bid and an Ask price. This is true whether there have been any actual trades on a particular option or not. The reason for a complete and fully populated chain at all times is that the market makers are always quoting every option whether anyone else is or not.
They literally make the market. If they want to buy at a price that is a touch higher than the Bid price shown, they are free to place a limit order to buy accordingly. We then become the best bid, rather than the market maker. We are in line in front of the market maker, and he will get less business. If he wants to get more he will have to raise his bid.