A hands-on options curriculum covering real trading concepts. Read the lessons, work through examples, and test your knowledge.
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Key terms in this lesson
Lesson 6: 2.5: Market Makers & Liquidity Providers
Understand how designated market makers and algorithmic dealers provide continuous two-sided liquidity.
1. Continuous Two-Sided Liquidity
Market makers are specialized financial entities designated by exchanges to maintain orderly trading. They do this by continuously quoting both a buy price (bid) and a sell price (ask) for a specific security.
Because they stand ready to transact with any incoming market order, they ensure that investors can buy or sell instantly. The market maker profits by capturing the bid-ask spread across millions of shares daily.
★ Core Rule: Market makers are obligated to provide quotes under both calm and highly volatile market conditions.
2. Risk Inventory Management
Quoting two-sided prices means market makers constantly accumulate inventories of stocks or contracts. If the market crashes while they are holding stock, they face massive losses.
To survive, market makers do not speculate. Instead, they use complex algorithms to dynamically adjust their quotes and hedge their inventory exposure in real-time, often using derivative instruments.
Click to enlargeKNOWLEDGE RECONNAISSANCE
How do market makers primarily generate revenue?
What obligation do designated market makers carry?
More lessons in this module
- 2.0: Overview of Market Participants
- 2.1: Retail Investors & Traders
- 2.2: Institutional Investors (Mutual/Pension Funds)
- 2.3: Hedge Funds & Proprietary Trading Firms
- 2.4: Investment Banks & Underwriters
- 2.6: Central Banks & Monetary Policy
- 2.7: Brokers & Financial Intermediaries
- 2.8: Regulators & Market Oversight (SEC, CFTC)
- 2.9: Sovereign Wealth Funds
- 2.10: High-Frequency Trading (HFT) & Algorithmic Firms
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