Tales From The Trading Floor

A reader suggested that I occasionally pass along stories of my days as a CBOE floor trader (market maker).  He was especially interested in whether market makers manipulated the markets to their advantage.

Anyone who peruses online forums knows that market makers are blamed for many things.  Included in the list of accusations: stock price manipulation, charging outrageous prices for options, dropping prices just when customers want to sell options, etc. 

Things are quite different today than when I was  member of the Chicago Board Options Exchange (1977 through 2000), but I'll do my best to tell you how the world of the market maker looked from my perspective.

Manipulating markets 

I never heard of any market maker being able to manipulate markets.  I did hear a story of how one market maker responded to an influx of option orders by unsuccessfully attempting to affect the stock price.  He lost a pile of money in the process.

The unfortunate part for me, is to read or hear about customers who believe that the market maker took advantage of them.  Instead, the reverse was true.  Large customers, such as the brokerage houses with their own trading departments – especially Goldman Sachs and Morgan Stanley – frequently 'picked off' the market makers by buying a bundle of call options moments before a large order hit the NYSE floor to buy shares in the underlying stock.  I don't want to make accusations in writing, and we had no evidence of the illegal action of 'front running,' but we always felt that these companies knew about the buy order that was headed to the NYSE.  Thus, they bought call options for their own account, anticipating that the stock price would jump, as a result of the pending buy order.

Afterward, we would write reports, make accusations, but all for nothing.  No one was ever punished and we were frequently the proud owners of a 'short delta' position as the stock was rising.  Somehow, we were never able to buy stock fast enough (in an attempt to hedge our option sales) because that large NYSE order arrived on the trading floor before ours.  The world moves much faster now, and I assume this problem no longer occurs.

In my opinion, market makers did not routinely (I use this word because I have no way of knowing if it ever happened) take advantage of customers.  Instead, it was the big customers who took advantage of market makers.  But people who make accusations on public forums would have no way to know that was happening – and I doubt many would believe it was true.

Just as customers blamed market makers, we market makers blamed customers.  Perhaps no one ever did anything wrong and it's just human nature to blame someone else when a losing trade is made.  But, I find that difficult to believe.  Placing blame truly depends on your perspective.

I never heard any inside information, I was never the recipient of any news.  And by the time I heard anything, the rest of the world already knew abut it.  Our edge came from being on the trading floor where we could see options orders before others.  In today's world, that's no longer true.  Every big order is 'shopped' off the trading floor before it is ever shown to market makers.

to be continued


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