Market Makers

A favorite boogieman to many traders, Market Makers are an indispensable ingredient that ensures liquidity, without which we’d not enjoy the fills we get each day.

One of my early strategies involved selling vertical Call spreads on the opening day of a new weekly option expiration. Often I’d be the only volume on that series. There certainly wasn’t another retail or institutional counterparty just waiting for my 500 lot, $5 wide UVXY credit spread. No, this was filled by a Market Maker, sometimes over and over again, as much as I want to offer.

Most of the narratives around Market Makers start to weaken once a trader understands what they do. They are there simply to profit off of the bid / ask spread, not to take directional risk. To address risks, MMs hedge your trades so that they are relieved of as much risk as possible. They do not care if you are long or short, only that they can be the one that fills your order. Payment for orderflow is MMs paying brokerages to direct your trades to them. A market making firm would not last very long if it accept any and all risks presented to them from traders.
Knowing that they need to offset risk is important. The type of order you enter can change the chances or ultimate price of a fill. A 4-legged spread can be much harder to fill than a simple Call or Put option order. I’ve been able to leg into spreads at better prices than pushing all legs as a single order.