Their goal is to provide liquidity to markets and facilitate price discovery by providing bids and offers to other market participants.
| Term | Definition |
|---|---|
| Bid | The highest price someone is willing to pay for something. |
| Offer (Ask) | The lowest price someone is willing to sell something. |
| Size | The amount of contracts or units one is willing to trade at a given price. |
| Make a market | To provide bid and ask prices, along with sizes, for other market participants to trade against. |
| Spread | The difference between the bid price and the ask price. |
| Hedge | A trade taken to reduce the risk of price movements in an asset. |
| Paper | The interested parties (clients, traders) transacting against market makers. |
| Broker | An intermediary between buyers and sellers that facilitates trades. |
| Tick size | The smallest allowable price increment between one level and the next. |
| Queue priority | The structure that determines the order in which participants at the same price level are filled. |
| Immediate or Cancel (IOC) | An order where any portion that can be filled immediately is executed; any remainder is cancelled. |
| Good for Day (GFD) | An order that remains active until it is executed or until the end of the trading day. |
| Good 'Til Cancelled (GTC) | An order that stays active until it is fully executed or explicitly cancelled. |
| All or None (AON) | An order that must be executed in full or not executed at all. |
| Fill or Kill (FOK) | An order that must be filled entirely and immediately, otherwise it is cancelled. |
| One Cancels the Other (OCO) | A pair (or set) of linked orders where the execution of one automatically cancels the other. |
On traditional open-outcry trading floors, traders gather in "pits" organized by the specific product they are focused on (for example, a corn options pit).
Market makers stand in the pit and continuously quote bid and offer prices, while brokers relay client orders between the pit and outside participants such as hedge funds or other institutions.
A typical flow might be: an outside client requests a quote → the broker passes that request to traders in the pit → a trader agrees to a price and size and fills the order → the broker confirms the execution back to the client.
Market makers execute large numbers of trades each day. For an option, they will calculate a theoretical fair value and then quote a bid slightly below that value and an offer slightly above it. When external participants trade against these quotes, the market maker aims to earn the "edge", the difference between the theoretical value and the traded price.
Not every individual trade is profitable, but over many trades the goal is that the collected edge, combined with proper hedging of risk, results in positive expected profit.
In the U.S., options on futures are primarily traded on CME Group exchanges: