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Ask the Former Market Maker

Follow us on Twitter @Schwab4Traders. This blog updates the last Thursday of the month. The next installment will publish on August 30th. 

The purpose of this ongoing blog is to share my 34 years of trading experiences garnered from The American Stock Exchange and The Pacific Stock Exchange, with the majority of my trading career spent as a Market Maker on the Chicago Board Options Exchange. 

These life lessons take a comprehensive look over those 34 years, and include conversations with other traders and clients, guidance on understanding the market, what really happens in the “Pit”, managing a trade, riding out a good trade, taking pain (the bad trades), walking away from an emotional trade, reducing or increasing risk and hopefully  getting paid for it. I will also highlight my favorite tools from searching to analyzing, to trade set up and lastly, to position (risk) management.

Look, I love trading stocks, indices, ETFs and futures but what I really love is trading OPTIONS. So what I need from you is your comments and/or questions about anything trading related, especially if it’s specific to options.

Since this is my first blog and I don’t have any of your questions yet, I will start with a common question I get asked. “Can the market maker see my order?”  I get this from clients regularly, along with “What did the market maker know?” or “As soon as I entered my order, the market went the wrong way!” or “I just got picked off by that market maker.”

Have you ever felt this way after a trade?  Well, the answer is no. This is an electronic trading world we live in now and it’s been this way for well over 15 years. Market making is just trading programs, where the trader adjusts his inputs on his program, like implied volatility or interest rates, all from the comfort of their offices. True there are still some pits with “open outcry” for those who like price discovery by screaming and yelling, but most of these pits still have some form of electronic order flow.

So let me be clear – when my customer order (I am a customer now) is sent from my computer through Schwab’s platform, it is either filled at the exchange through a broker or if nothing done, held there at the exchange, until that order can be executed at that price electronically.  If my order #4568394050943 (not my name nor account #) is filled, the other side of the trade does not know, nor care, who it is, the other side only cares that it was a bid or offer their trading program liked.  Market makers could care less about my 10- or 25-lot order.

I genuinely believe that it is more preferable to be a customer now than a market maker. Back in the day, at one point I traded over 80 stocks at the same time.  That doesn’t sound like much but remember I am making quotes for all of the calls and puts, bids and offers for each, times 10 strikes and times six different time frames, which gives you at least 38,000 quotes a second. 

I was required to buy calls in a down market and sell calls in an up market. Plus with many stocks then, there may only be two to five market makers for each stock, which means it was difficult to shy away from bad trades. Now as a client, if the market tanks, I can cancel my bid and re-enter it five points lower but the market maker has to make a good bid all the way down. Like I said before, it’s good being a customer now.

Another question I get asked regularly is to describe my best and worst trade. I will share plenty of stories like this down the road, and if you can learn something from my experiences, all the better. Sure I had killer trades and for sure I had trades that killed me, but they were all relative to each other, meaning they were all proportionate to the amount I could make versus the amount of risk I was taking on (the amount I could lose). 

We’ll talk about that and more in our next entry, including our next topic “Why trading should be like baseball”. Send us your questions here.

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Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled “Characteristics and Risks of Standardized Options“ before considering any option transaction.

Multi-leg options strategies will involve multiple commissions. Spread trading must be done in a margin account. Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received. Commissions, taxes and transaction costs are not included in the examples used in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

Past performance is no guarantee of future results.

Schwab does not recommend the use of technical analysis as a sole means of investment research. Past performance is no guarantee of future results. Investing involves risks, including loss of principal. Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against loss.

All stock and option symbols and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

All references to subjects (securities, indexes, futures contracts, and options contracts) were derived based on screens conducted by the writer for certain anomalous activity such as volumes, volatility and other related market data. As needed for brevity, the writer may have applied discretion when choosing among screen outputs for inclusion. Such discretion may have been based on news reports or other considerations of public interest. The views or opinions are those of the writer, and are subject to change without notice. All referenced subjects were chosen for illustrative purposes only and should not be considered recommendations, offers to sell, or solicitations of offers to purchase.

Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, business, and other conditions. Schwab Center for Financial Research (“SCFR”) is a division of Charles Schwab & Co., Inc.

The information presented does not consider your particular investment objectives or financial situation (including taxes), and does not make personalized recommendations. Any opinions expressed herein are subject to change without notice. Supporting documentation for any claims or statistical information is available upon request.

The information provided here is for general informational purposes only. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

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