Tag Archives | market maker

How Good is Your Trade Execution?

I read in your blogs that your preferred underlying IC instrument is RUT. How often do you get good execution prices with RUT spreads? It's hard for me to get the "mid-price". Do you have any suggestions on execution prices?



Hi Keiser,

Short answer: I don't know how good the executions are.  This is primarily due to the fact that I trade options that are not very liquid.  They are low volume options, and I have no comparative data.

Details: My broker (IB) advertises that they achieve excellent fills, and offer evidence.  I choose to believe them.  However, I'm sure it only applies to single option (no spreads) that have a lot of public order flow.  My trades are almost certainly being made with market makers, or some other professional trader, and I can only get a good fill when they are willing to provide it.

I never try to get the midpoint on my credit spreads or iron condors, and I am happy to get 10 cents worse than mid.  I will go as far as 15 or 20 cents worse than midpoint – if I 'need' the spread for risk modification or when I want to exit to reduce risk.  When collecting the profit, I have more patience.

When trading with the market makers, I don't know how we can ever know what they are thinking or how they value the specific trade that we are trying to make. 

Sometimes when selling vega (for example), the market makers are short vega and are willing to pay up to get some positive vega.  When that happens we could get midpoint – or even better – for selling positions with positive vega.

If trading 100-lots, then those market makers are going to have some incentive to examine our orders and look for an appropriate hedge that allows them to take the trade.

When customers trade 1- or 5-lots, then it may not be worthwhile for the MMs to spend any time with our bid or offer.  My guess is that their computers are set with parameters that scan spreads.  In other words, their computers and the algorithms they set, make the trade decisions.  If that is true, we can never judge how good the fill is – but it will never be 'good.'

You could enter the same order with several brokers and see which one delivers the best execution.  I suspect that's a waste of time, but it is research and you may discover a path that saves significant money – if you have the time and patience to make that attempt.

My only useful suggestion is to know just what you are willing to pay (or collect) for the trade and not to go beyond that limit.  I understand that 'knowing' the limit is difficult – especially when we have no idea of the true bid/ask spread for our trade.  One of the serious defects with electronic trading is that customers do not get to see the real (inside) market.  We only see the published markets, and those are useless.

Side opinion:  When we enter bids and offers without a clear view of the real market, then we are becoming de facto market makers.  We lay our cards on the table and others can take or reject our trade. 

Thanks.  Good questions.


Read full story · Comments are closed

Trading and Liquidity

Hi Mark,

I have a few questions on option liquidity that I was hoping you could clarify for me:

1) Before I enter a trade, should I look at the options volume of the strike I am buying (or selling) to determine whether that option is liquid? Or should I be looking at the option’s open interest? Or a combination of the two?

2) Should the bid/ask spread also be taken into account to determine how liquid the option is? Also, typically, how tight should the bid/ask spread be for the option to be considered liquid?

3) If I am interested in entering a spread trade (e.g. a vertical credit spread) and one of the options in the spread has very high volume and very high open interest, but the other option does not, would it be a good idea to look for a different spread where all the legs are liquid?

4) I have seen strikes with very high options volume but very low open interest. Does that mean that the options at those strikes are not liquid enough because the open interest is low (even though the option volume is high)?

5) Which one of the two indicators (option volume or open interest) should I be looking at before entering a trade in order to ensure that, if I need to close out the position, that will happen quickly and at a good price?

6) Are there any rules in the exchanges that limit how wide a bid/ask spread can be? For example, if I enter a trade when the bid/ask spread is fairly tight and then, due to lack of liquidity, the spread gets wider, is there a maximum limit to how wide that spread can become? Also, is there a risk of not being able to close out that position due to lack of liquidity?




Hello DC,

I never paid much attention to liquidity when trading options on individual stocks, and continue to believe that low volume is not important for most traders.  However:

1) Liquidity is important when you believe that you may want to trade those options again, prior to expiration. For example, you may want to close the trade to limit risk, lock in profits, or roll the position to another month. If you plan any of those trades, then liquidity is important from the perspective of efficient trading.  It's easier to get your orders filled when the market makers want to trade, rather than avoid trading, the options of a given underlying.

If you avoid trading options with limited volume or open interest, you may (and may not) save yourself some grief.  In other words it's a safety play that may avoid trouble later.  It's a good idea to avoid trouble.

However, if your plan is to trade these options once and forget about them (not good risk management technique), then liquidity does not matter.

OI on the specific strike is not important. If the OI is decent for the options of this underlying, that should be good enough to encourage you to make the trade. I believe a high OI is more important than high volume but I cannot truly explain just why this is true.

2) Yes bid/ask matters to a point. I cannot tell you how wide the idea bid/ask spread 'should' be – because the bid/ask is not that important by itself. What counts is the TRUE bid/ask, and that is always invisible.

In other words, where do the market makers trade? How far above the bid can you sell? How far below the offer can you buy? That's what matters and you cannot know that without attempting to trade these options and learning the true bid/ask spread (referred to as the 'inside market').

3) No. If one option has good liquidity, it is almost guaranteed that the spread will have good liquidity because the market makers will take the other side of your order.  Warning: You must enter the order as a spread and not as two separate orders.

4) Difficult to say. If someone buys 10,000 calls and then the OI remains near 10,000, there is not much liquidity – for your purposes. Sometimes large blocks are crossed by professionals and neither market makers nor individual investors take part in the trade. So if the volume is low, you never really know how easy it will be to make trades at fair prices. The usual case is that high OI and high volume go together, but as you indicate here, that's not always the case. If he market makes want to trade, they will make good markets.  If the public doesn't want to trade, there will be low volume.

Because you don't know the mindset of the market makers, you can only discouver the truth by entering orders.  When you discover poor quality markets, cross that underlying off your list.

5) You cannot get any such guarantee. If it hits the fan, bid/ask spreads widen and no matter how high the quality of previous markets, the market makers may back away from trading, leaving you poorly placed when attempting to exit or adjust.   But, if either OI or Vol is high, you 'should' be okay. But 'should' is not a 100% assurance.

6) Yes, there are limits. However, for the life of me I cannot understand how bid ask spreads can be as wide as they are. The exchanges allow exceptions to the rules, and it seems to me that the rules have been ignored for years. To find out the official rules, you can ask that question: options@theocc.com

The truth is simple:  If the market markers become afraid to trade – and that should be very rare – there is nothing you can do.  Thus, good OI numbers and good volume should make it easier to trade, but unusual circumstances (flash crash for example) may cause any options to become diffficult to trade.


Keep this in mind:  If you are attempting to trade 5-lots, you need not be concerned with any of this.


Read full story · Comments are closed

Trade like a market maker?

Visit the new home page for Options for Rookies


The problem with my spread order is that it is sent to the
market maker who supposedly provided the best price.

On the retail
front end, I can't see the market makers' quotes. Do you know how to
connect directly to liquidity (in a way that I can see MM's quotes)?

Another method I can think of is to come out with a good algorithm for
legging in. This is much complicated and I hope I would not need to go
this route. My opinion is, in order to get into more liquidity, I may
need to learn how to trade like a MM.



Hello John,

It's difficult to know where your orders are sent without asking your broker.  However, they are never sent to 'a market maker.'  The orders are send to an exchange, and that should be the one displaying the highest bid (or lowest offer).  Sadly that is not always true because some brokers accept bribes payment for order flow.

If you trade enough size, your broker will (gladly?) get a quote for your order.  When I was trading 100-lots of iron condors, I found that the people who provided those quotes were, to put it simply, out to cheat me.  In other words, when I tried to find liquidity, my broker (IB) could not have done me any worse than sending the quote request to the people they chose.

I no longer have access to such quotes (I trade much smaller size), nor would I seek them.  I know they are useless to me.  I blame IB for that (they asked the wrong 'liquidity suppliers' for quotes).

I look at the bid/ask spread for each leg of the iron condor as well as the bid/ask for at the iron condor itself. I then decide if I want to play.  If yes, I enter my order at a price I will accept.  If I don't get filled, so be it.

A few years ago, whenever I entered an order, the IB software showed (for 2-3 seconds only) a counter offer.  In other words, I had the ability to see the true market.  That allowed me to enter a low-ball bid to see the true offer.  That service is no longer available, and we are flying blind when entering orders.

I complained to IB that in reality, I am the market maker.  I am posting a bid (or offer) with no ability to see the true market.  "That's not fair" I tell them.  "Too bad" say they. 

So, I play market maker and hate it.  To  make matters worse, IB charges a fee to cancel an order and replace it with a better order.  Imagine – they charge me, the true market maker in this scenario, to make a better market.  It costs me cash to raise my bid or lower my offer.  It's an obscene system, but I don't see how I can do anything about it.  The overall cost to trade at IB remains untouchable for me.

If readers have suggestions or a work-around, please share.


1) You will not find a good algorithm for legging in.  In my opinion, there is no such thing.  You would have to know which way the market is moving to leg the first side of the trade.  And if you can get that part right, why would you 'waste' a good trade just to complete the iron condor?  Use that (impossible to build) algorithm to day trade and make millions.

2) You cannot trade like a market maker.  You are never aware of large orders that are being quoted.  You don't know anything about large spreads that are being shopped or sitting with the specialist.  Many times just knowing an order is there allows you to make a trade and then go get a piece of that large order.

You never get to buy on the current bid – and if you do, you will discover that it is no longer the bid and may even be the ask price when you are filled.

There may be books that explain how a market maker trades, but the MM's advantage is not available to you.



September 2010 issue now available

Read full story · Comments are closed