Options Market Making
Options market making is one of the most difficult jobs on Wall Street. With historically low implied volatility, profit margins on most trades are extremely small. In addition, the rules and regulations of exchanges make options trading a complicated process. Dealers must post bids and offers in byzantine market structures. The result is an environment that resembles a shooting gallery for ultrafast computers.
Options market making is a growing industry with hundreds of market makers offering their services to stock exchanges. They range from large banks to individual traders. In recent years, the concept of options market making has become popular, with listed companies having hundreds of different options contracts with varying strike prices and expirations. Many of these instruments require highly complex algorithms and models.
Lead Market Makers: Market Makers must maintain an active options market on the Exchange. Their activities must contribute to price continuity and minimize the impact of a temporary disparity between supply and demand. These types of trades require that market makers act in the best interests of investors. They must also ensure that they comply with the criteria outlined in paragraphs (c) and (d).
To reduce this risk, market makers can compensate for their long position by taking a short position in another option. In some cases, market makers may not be able to continuously trade in the underlying stock or option. Depending on the type of options market, they may not be able to trade continuously. However, they may be able to set bids and ask for quotes for options that have large deltas.
While Market Makers are not required to execute more than 25 percent of total options contracts, they may receive a preference over a Lead Market Maker. This means that if a Market Maker consistently performs a good job, they may gain a position in the options market. For example, a Market Maker may decide to allocate more contracts to an option that has less liquidity.
Options market makers are obligated to notify the Exchange of any material change in the application for the options class that it is responsible for. If the exchange is unwilling to allow a firm to use the options market to obtain short exposure, it will not be permitted to engage in short selling. A short-selling ban could have detrimental consequences for the future of the options markets.
In addition to the NBBO, there are four major exchanges that operate their own options auctions. CBOE’s AIM and ISE’s PIM have each gained a substantial share of the market. The two other exchanges, the AMEX Cube and the NYSE Prime, each have a comparatively small market share.
An options exchange may also employ a make-take model, which pays a trader to post a limit order. The taker-maker model pays a trader a fee per contract for posting liquidity. Using this model is popular with high-speed traders.