MARKET MAKERS IN OPTIONS AND FUTURES
Same name, different roles
Let’s pick up where we left off.
The E-mini S&P 500 futures market is an order-driven market and I will show that market makers play no role in this market, except for block trades and the like. Conversely, I will also show that SPX options operate in a quote-driven market, as defined in the last post.
To do this, let’s introduce an entity called the OCC and clarify the differences with the CME.
The Options Clearing Corporation (OCC) is the central clearinghouse for options and equity derivatives markets. Established in 1973, it falls under the regulatory oversight of the U.S. Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC). The OCC serves as both the issuer and guarantor of options and futures contracts, ensuring that the obligations of the contracts it clears are met.1
On the other hand, the CME Group is a marketplace where traders can buy and sell futures and options contracts across various asset classes. It also provides clearing and settlement services through its division, CME Clearing. However, its main function is to provide a platform for trading, while the OCC’s role is to ensure the fulfillment of trades in those markets. CME Clearing performs a role similar to the OCC but operates within the markets of the CME Group.
So ultimately
CME Group: Provides the marketplace for trading futures and options and has its own clearinghouse, CME Clearing, which clears and guarantees trades made on its exchanges.
OCC: Clears and guarantees options and futures contracts traded on other exchanges, including the CBOE (where SPX is traded).
Each clearinghouse is tasked with the settlement and clearing of trades on its respective exchanges, managing counterparty risk, and ensuring the integrity of the markets it oversees. Although the OCC and CME may work together on certain initiatives, such as cross-margining, they run their clearing services independently.
The OCC issues a report detailing the instruments traded on the exchanges it clears. This report includes, among others, information on VIX futures and SPX options, but it does not cover SP500 futures or other instruments traded on the CME.
Like the COT report, the OCC report classifies traders and their orders. A ‘customer order’ is defined as an order from a non-broker/dealer customer account, a ‘firm order’ is from an OCC clearing member firm’s proprietary account, and a ‘market maker’ is a firm or individual who actively provides buy and sell quotes for a security, along with the market size for each. Market makers in regulated or OTC markets have specific obligations, such as the need to continuously offer prices.
We’ll begin our analysis with the report on the VIX futures; following that, we’ll examine the report concerning the SPX.
The image below shows a section of the Options Clearing Corporation (OCC) report titled "Volume by Account Type". The report displays a table with data on the trading activity in futures contracts, including the VIX, broken down by the type of account holder: customer, firm, and market maker. The values for market makers in the VIX futures market are shown to be zero for the trading day of March 22.
The same for the High Yield Corporate Bond Index Futures below:
And so on…
Instead the OCC report on options offers a contrasting viewpoint. The substantial presence of market makers, points out their function as intermediaries in conducting transactions between firms and customers, as defined by OCC itself, and ensuring market liquidity.
In line with this, the following image shows the 'Volume by Account Type' report for SPX options on the Options Clearing Corporation (OCC) website. The data indicates that market makers account for approximately 50% of the total volume traded, whereas in the futures market, such as the VIX futures, market maker values are zeroed out. This difference highlights the varying roles and obligations of market makers across different financial instruments.
An analysis of traded volumes over an extended period shows that this is a consistent pattern, indicating that market makers are counterparties in all options trades. However, this doesn’t imply they hold onto all the open interest at day’s end.
When we look at VIX futures over a longer timeframe, a negligible amount is transacted through market makers, mainly involving block trades that are executed outside the standard futures trading book2.
This pattern is also true for the CME, despite the lack of a volume report from the exchange, as confirmed by the CME’s market maker directories3 which is a list of firms authorized to assist as market maker.
It’s clear that for the 3 main indeces (Sp500, NASDAQ, DOW) market makers are designated only for particular trade types, including BTIC, TACO transactions4, and BLOCK TRADES.
For less liquid instruments, they may participate in the order book but playing a smaller role compared to their involvement in the stock and options markets.
Notably, the entities serving as market makers for the E-mini SP500 are prominent industry players.
The need for a market maker for SPX options arises from the presence of multiple expiration dates and multiple strike prices that require liquidity.
In contrast, for futures, there is only one active expiration, the front month, and a single level at which traders exchange contracts, ensuring that supply and demand find a counterparty. Beyond certain size limits, trading moves away from the book to the designated market makers.
Next time, we will introduce the Commitment of Traders (COT) report to clarify why it still includes market maker data for the E-mini S&P 500 futures.
https://www.investopedia.com/terms/o/occ.asp
More details on this will be provided later.
https://www.cmegroup.com/education/market-maker-directories.html
BTIC enables market participants to trade futures contracts at a basis to the official closing value of the underlying index ahead of the actual cash market close; same action can be taken against the cash index market opening level with Trade at Cash Open (TACO) futures.
Block trades are privately negotiated futures, options or combination transactions that meet certain quantity thresholds and are permitted to be executed apart from the public auction market.
Really enjoying these updates, Giovanni. I'll be saving this for reading a bit later, due to busy travel schedule. Look forward to sharing my thoughts. Stay in touch.