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Role of Market Makers

The basic role of market makers in the 
options exchanges is to ensure that the 
markets run smoothly by enabling traders 
to buy and sell options even if there are 
no public orders to match the required 
trade. They do this by maintaining large 
and diverse portfolios of a wide range 
of different options contracts. Market 
makers basically make sure that there is 
both depth and liquidity in the options 
exchanges. In their absence, there would 
be significantly less transactions carried 
out and it would be much harder to buy 
and sell options. There would also be less 
options in the way of different contracts 
available in the market. Enabling traders 
to execute transactions quickly, even 
if there is no willing buyer or seller, in 
turn ensures that the exchanges operate 
efficiently and traders can usually buy and 
sell the options they wish to.

Risks in Market Making

The primary risk a Market Maker can 
face is a decline in the value of a security 
after it has been purchased from a seller 

and before it is sold to a buyer. Market 
Makers are always counterparties to 
trades done by informed traders and 
in case of any volatility in the market; 
the Market Makers are often stuck with 
wrong positions. Another fatal risk for 
a Market Maker is to not have the latest 
information. The Market Makers can 
survive by managing risks only if it is 
possible for them to receive and respond 
to information quickly. Strong markets 
need Market Makers and to have Market 
Makers it should be possible for them to 
survive & succeed without big losses.

Market Makers in Major 

Exchanges

United States

Previously, the great majority of the 
capitalization of U.S. equities was traded 
on a listing market – the New York Stock 
Exchange – that executed nearly 80% 
of volume in those stocks. Today, the 
NYSE executes approximately 26% of the 
volume in its listed stocks. The remaining 
volume is split among more than 10 public 
exchanges, more than 30 dark pools, 

and more than 200 internalizing broker-
dealers. This increased fragmentation 
and the trading venue competition that 
accompanies it have caused traditional 
exchanges to change their models of 
liquidity provision. In addition, markets 
that were primarily public limit order 
driven, came to the realization that 
liquidity would not endogenously 
appear for illiquid stocks and that formal 
structures were necessary.

As a result of these changes, the NYSE 
abandoned traditional specialists shortly 
after it merged with Euronext. Today, 
for trading occurring on their NYSE and 
NYSE/AMEX equity units, they call their 
market makers Designated Market Makers 
(DMMs) and they are very far removed 
from their specialist roots. DMMs are 
required to maintain a continuous bid 
and offer of at least 100 shares. They are 
further required to quote at the national 
best bid or national best offer at least 15% 
(10%) of the trading day for securities 
trading over (under) 1,000,000 shares per 
day. For those times that they are not at 
the National Best Bid and Offer (NBBO) 

The most common type 

of market maker is a 

brokerage house that 

provides purchase and sale 

solutions for investors in 

order to keep the financial 

markets liquid. A market 

maker can also be an 

individual intermediary, 

but due to the size of 

securities needed to 

facilitate the volume 

of purchases and sales, 

almost all market makers 

are or work for large 

institutions.

COVER STORY