2.2 Market Makers

As mentioned earlier, a middle man ensures that there is someone on the other side of every trade in the market, and they are called market makers. If you want to sell a call, there will always be someone to buy it from you. If you want to buy a call, there will always be someone to sell it to you. Nearly all trades go through a market maker. Market makers primarily make money off of the spread between the bid and ask price of each option that trades on the market. However, it is rare that their books will naturally remain neutral. That is, if most participants buy calls, then they are net short calls, and stand to lose a lot of money if the price of the underlying rises. In the following sections, we will discuss this risk exposure that all market makers must bear, and how they manage it.