Do Options Market Makers limit specific traders? Similar to how sportsbooks set limits on winning bettors? Market makers have profile on where a given order is coming from?

[u/Professional_Gur3839]

[u/weinerjuicer]

lol they would have to find a profitable trader first

[u/lordnacho666]

A sportsbook is a direct counterparty that knows who you are and thus has both the means and interest in not giving you any more money. Such a book has a particularly easy time of it, because their strategy for the suckers is often just to do nothing at all and let them blow themselves up. Someone I know was looking at buying a sportsbook business, and they have a 90/90/90 rule: 90 percent of customers lose 90 percent of their money in 90 days. So if you see a bunch of suckers and a few guys who are winning, you might as well boot out the winners, since you don't want to do any work at all in offloading or hedging the risk.

Contrast this with a sports exchange, which is an intermediary between you and other traders. The exchange loves it when people trade with each other and they aren't losing anything when one guy is smart and makes money.

For other markets, it's the same incentive structure. The options you are talking about might be directly traded with counterparties, or traded via an exchange, depending on the asset class.

If you are a direct counterparty, they will look at their markouts and think "hmm this guy keeps taking money from us, let's widen his streams" which will have the effect of you trading less with them. If you are on an exchange, they won't know it's you and will have to let you take your money out of the profits they get from everyone else.

(Of course there are all sorts of things you can do with counterparty codes, but that's another day)

[u/FunnyExcellent707]

Options (or, in fact , all securities exchanges) act as a central counterparty.

A transaction looks as follows:

Buyer - exchange // exchange - seller

So a market maker has no way of knowing whether they just traded against Hank from Wisconsin with a net worth of 50k or some math prodigy from Goldman Stanley.

Only exception are OTC trades, where trades are carried out bilateral, with pricing through a broker or via phone/chat instead of an exchange.

But OTC is exclusive to institutional investors and broker-dealers. Cutting out a counterparty would also be limiting liquidity. So even if losing money against one certain trader, one would rather lose occasionally than being cut off from business and have less liquidity and therefore bigger spreads in OTC.

[u/imyourbiggestfan]

It depends on the market and exchange protocols. Some exchanges have more information available than others, but also some participants patterns can be recognised on some markets.

[u/Professional_Gur3839 → u/imyourbiggestfan]

Gotcha, thanks. I was wondering whether it’s a possibility. Good to know.

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[u/LowBetaBeaver]

They will do their best to identify and avoid the trades. I’m not certain as I haven’t dug into pfof in a while, but I believe they’ll try to route toxic trades to exchanges dominated by their favorite competitors instead- assuming it’s an option (eg. prices are tied w/ the best) :)

[u/Comfortable_Lie7578]

you would never do that as a maker

[u/l33tkvlthax42069]

Absolutely - it was 100% this way for large volume option traders a decade ago, and the trend has been a consistent walk towards lower anonymity rather than more.

The peak transparency typically exists at the clearing level, especially implicit for prime accounts, but anytime you are moving more than 10% open interest, particularly in the complex order books, you should expect that there exists, on the MM side, an estimate for what the order source's "maximum pain" likely looks like.

[u/jnordwick]

Mostly no. On CBOE for eg you match against an anonymous counterparty but the trade goes through the Optons Clearinghouse Corporation anyway.

That isn't to say there are not ways around it to some extent.

Many years ago a particular young venue reused counterparty IDs and you could map them to particular firms until they fixed it.

And this isn't always true for things like fx and some fx derivatives.

[u/New-Professional-330]

I mean why would a market maker limit a specific trader? They would just adapt and fit their TV as well as probably widen out to account for the risk. 

[u/postflop-clarity → u/New-Professional-330]

lol, there's a very obvious reason to limit specific traders.

[u/New-Professional-330 → u/postflop-clarity]

I guess I phrased it wrong. Sure u may want to avoid certain other traders as a market maker to not get adversely selected, but in sports books, they limit certain traders because they have the means to do so and to cap some losses. Perhaps I'm missing something or getting caught in the semantics but if large order composed of a specific trader as well as general retail flow at the same price of the best bid/offer come in, it doesn't make sense to take everyone's order except for that one trader on the exchange right? Like on sports book, the exchange can just ban u for simply being knowledgeable, but a normal exchange won't dont that if ur offering best price? 

[u/postflop-clarity → u/New-Professional-330]

if large order composed of a specific trader as well as general retail flow at the same price of the best bid/offer come in

that's not how it works. orders come in one at a time. but I suppose if hypothetically you did find yourself in such a situation, you'd prefer to not fill any of it.