Finance & Investing

Futures Market Makers

Futures market makers are professionals who provide liquidity in financial derivatives markets by adjusting their bids and offers. They also provide strategic trading by setting fair prices and compensating for their risk with spreads. Market makers have different motivations and techniques for getting the job done. Generally, they are paid based on the volume of business they can provide and the risk they are taking. This may be in the form of a fee or commission.

CBOE

The CBOE has developed criteria to distinguish between market makers, casual traders, and professionals. These criteria are designed to prevent the granting of market maker status to unqualified individuals, and to ensure that the market maker designation is only bestowed to those who meet certain minimum requirements.

While these criteria are generally supported, some of them should be modified. In particular, the criteria are not intended to be too narrowly focused. Rather, the requirements are intended to ensure that members have access to the appropriate net capital requirements for security futures contracts. If there are any unduly stringent standards, they could prevent an active liquidity supplier from receiving market maker treatment.

A market maker’s bid-ask spread is a measure of his profit from his trade. For example, if he quotes a $5.50 buy price, he will be earning a spread of $5. As a result, he might only have one valid quote available in the system for the given contract month. He might decide to take a less expensive route, such as closing the market.

Some markets are very competitive, and the introduction of a market maker has improved the liquidity of those markets. These competitors improve transparency and reduce the bid-ask spreads. Additionally, a market maker provides more efficient access for other investors to purchase or sell products.

It is possible to be a futures market maker and make money, but that is not the main purpose of the role. Market makers are compensated for their work by receiving fee rebates for fulfilling their obligations. Also, a market maker’s inventory of stocks and other securities is not hedged. However, some firms do use hedging in order to minimize their risk.

To be an approved market maker, a person or entity must first qualify as a member of the exchange. Members who are eligible are then deemed as market makers, assuming they fulfill the basic quoting and other performance criteria. At that point, they are granted market maker status for all security futures contracts.

Closing thoughts

Market makers may receive a fee if they provide liquidity to a high-volume client. Market makers may also charge a fee for responding to a quote request. Traders who want to be quoted in a specific timeframe can request an associated person to begin a quote request.

Typically, they enter a quote into the exchange’s computer system, and the computer system then transmits the information to the market maker. During the next business day, the quote is updated and is entered into the order book. Traders who choose not to execute the quote are removed from the order book.