Why does everyone hate the market makers?

Market makers serve a purpose. It may not be as honorable a of profession as being a surgeon or teacher, but they take a lot of abuse from individuals who trade options. I’m sure some complains are justified, but there is no reason to blame the market makers every time something goes wrong with a trade.

What bothers me most about such accusations is that they come from people who do not understand and have made no effort to understand. They don’t recognize the special circumstances of the vehicles they are trading (a huge mistake), then don’t understand the risk involved in a trade, and then seem to expect market makers to toss cash in the trash, just to satisfy the unreasonable demands of a customer.

Example

There are still traders who buy and sell VIX options with no idea of what they are trading. Then when something goes wrong, they love to blame the market makers for cheating them. If these traders would simply read the rules, or ask questions of their brokers, there would be no problems. Instead they love to trade first and then find someone to blame. It’s the same for Europeans style index options. Many customers have no idea that these options are European style. Worse than that, they never bother to understand how the final settlement price is calculated. What they do very well is complain bitterly.

I trust that all readers here know that VIX options are different from other options. The underlying asset is NOT the spot VIX index. It is a VIX futures contract. And to make it more complicated, you cannot assume which contract is the underlying for a specific VIX expiration cycle. Care must be taken to learn which futures contract underlies the options that you plan to trade.

As if that were not sufficiently complicated, VIX options are European style and cannot be exercised prior to expiration. This is not a product for the under-educated trader. Yet many option rookies go out and trade these options and lose money – just because of ignorance. Do they accept the blame? Of course not. It must be the market makers who are cheating them.

Example

On a forum run by one of the discount brokers, a poster complained that market makers ‘manipulate’ the prices of options, and that he, the intelligent customer, would never sell a position for less than it’s full value to such people.

What he doesn’t get is that when he wants to sell a position at full value (think of a call spread for which both options are in the money, the strikes are 5-points apart, and the spread will be worth $500 at expiration), he expects some market maker to pay him that $500, and also pay commissions for making the trade. That would guarantee a loss for the market maker. Nevertheless, this customer still wants someone to pay $5 for the spread he wants to sell. When he cannot get that price, he blames the market makers for bidding less than the spread is worth.

I am not suggesting that the market maker is your friend. I am not suggesting that he/she is working to give you free money. However, many are decent, honest citizens trying to earn a living. If customers were better educated and stopped trowing away money, there would be less reason to seek someone to blame. Each trader can begin by observing two simple rules: never enter a market order when trading options and be certain that the specific options you are trading do not have special rules.

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