Back in the day when there was only one exchange for an order to go to, individual market makers provided the liquidity to fill customer orders.
Those market makers competed with each other for price discovery. This is how it worked on the Cboe …
A broker walked into a trading pit of 15 to 50 people. (In the larger pits with 100-200 people the brokers stood in the same spot all day).
He would shout out the option he needed a market in. He never said if he was a buyer or a seller, therefore every market maker had to shout back the highest price he would be willing to pay and the lowest price he would sell that option.
The market maker that shouted their market first had the right to take all of the order or whatever portion of it they wanted, the rest was divided between the remaining market makers that wanted to buy or sell that option at that price.
It was the best job in the world!
Until things started to change …
Multiple exchanges, stock trading in pennies and payment for order flow.
In sharp contrast to the old days of people standing in a crowd not knowing if the orders were buying or selling, payment for order flow provides the DMM with the answer to the test!!
Robinhood sends Citadel their order exclusively. They see the buys and sells before they trade it. That is a HUGE advantage. It is like the fox guarding the hen house.
Fun fact: Bernard Madoff (ring a bell?) pioneered payment for order flow, although it didn’t have anything to do with his later criminal behavior.
In February 2009, the NYSE applied for permission from the SEC for payment for order flow.
The NYSE has a Designated Market Maker system to execute these transactions and they are listed on the exchange’s website:
There they are, all THREE of them!
Oh! They do have Supplemental Liquidity Providers, as well. They provide markets (add liquidity) in the busier names that trade a million shares or more.
By now I am sure you know which side I am on.
Those huge liquidity providers long ago took out us little guys.
I know I am too close to remain objective but … how can this be right?
Let’s Review My Winning Trades
My Twitter (Ticker: TWTR) spread I sold the Feb12 44/30 put spread and collected $2.36 when the stock was trading $45.93.
Thursday, TWTR traded up to $52.25 and bought in my put spread paying $1.06 for a 55% gain.
My SPDR S&P 500 (Ticker: SPY) Feb05 381/371 put spread I paid $1.65 and sold it Thursday at $3.94 for a 138% gain! Woo hoo!
My IShares Silver Trust (Ticker: SLV) Mar17 23.5/25 call spread is only up $.05 with SLV up to $25. Let me show you why.
See that blue line? That is the implied volatility of the options.
It has soared!
When I put the spread on the IV was 45.24 on the 23.5 calls and 46.61 on the 25 calls.
The IV of the 23.5 is now 60.41 and the 25s is 65.57!
The stock has gone our way, now we just need the vol to settle down and the spread will go higher when those 25s come down.
I am always rooting for the little guy.
Thanks for Reading … See You Next Tuesday!