Dawn Pennington

Make or Break Options Trades

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No doubt you've heard the financial media blame "market-makers" for everything from an individual stock's slide to fluctuating currency rates to a sudden surge in options trading. Let's look at just how much power these market-makers have in the stock, currency and options arenas, and what you can do to counteract their influence.

Stocks range in popularity from highly liquid, blue chip names to sparsely traded, emerging companies. Every major exchange has designated (also called primary) market-makers, which act as go-betweens. Similar to banks with currency, they buy from you at the "bid" price and sell to you at the "ask" price.

Each market-maker must provide reasonable bid/ask spreads and trade up to a maximum number of shares per day, meaning they are required to create the market for the stock with the understanding that they have immense but ultimately limited financial resources. This deters frenzied trading and helps to stabilize volatility.

There are usually several market-makers per stock, some who supply multiple exchanges. Not every trade has to work through a market-maker, but they are there to ensure that an orderly and reasonably liquid market exists even if there is lopsided buying or selling, like we saw during the recent correction.

If the bid/ask on a particular stock is large, that typically means that the market-maker expects very little volume or that the stock's price is highly volatile. Market-makers, incidentally, "see" your hard stop levels because they have access to all of your broker's data, which is why, if you can maintain a system, it is best to keep "mental" stop losses to ward off the effects of opportunistic market-makers.

Currencies offer the most liquid trades, usually trading more than 10 times the total of domestic stocks daily. Exchanges facilitate these trades, with retail (and some institutional) orders placed via brokers.