10. Role of Market Makers in Options Trading

When you place an order to buy or sell an option, especially on liquid indices like NIFTY or BANKNIFTY, more often than not it's filled almost instantly at a fair price. How is that possible even for strikes that no one might actively be trading at the moment? Thank the Market Makers. They are the unsung heroes (or villains, depending on your perspective!) who provide continuous prices for options, ensuring there's always a buyer or seller available. Let’s explore who they are, what they do, and their impact on the market.

Who are Market Makers?

Market makers are typically specialized trading firms or the proprietary trading desks of brokers. Their job is to provide liquidity – meaning they stand ready to buy or sell to keep the market moving. They do this by continuously placing two-sided quotes (both bids and asks) for option contracts. A market maker might simultaneously post an order to buy an option at ₹100 and sell at ₹102, for instance. They profit from the bid-ask spread and by managing the risks of the positions they take on.

In the words of one explainer, “Market makers are firms or individuals that provide liquidity to the markets by continuously buying and selling securities. They mostly supply limit orders... offer bid/ask quotes on both sides.” (The Ultimate Guide to Understand Market Makers). In essence, they ensure you rarely see an empty order book.

Market Makers in India:

On the NSE, for the main indices and liquid stocks, there isn't a formally designated market maker for every product (unlike some markets where specific firms are obligated to make markets). However, in practice, high-frequency trading (HFT) firms and algo traders act as market makers. They have complex algorithms that constantly quote prices and hedge their positions. For less liquid segments (like the SME exchange or certain commodities), NSE does appoint official market makers with obligations (The Ultimate Guide to Understand Market Makers), but for Nifty/BankNifty options, it's more of an open playing field of multiple participants who take on that role. Big global firms (like Optiver, Virtu, Tower Research, etc.) are known to be active in providing liquidity in Indian markets

Interestingly, a resource notes that in India, there are no official equity market makers for main equities/derivatives, but HFT firms fulfill this role by providing continuous quotes (The Ultimate Guide to Understand Market Makers). So while you might not see "Designated Market Maker" for Nifty options, rest assured someone is performing that function.

Impact on Bid-Ask Spreads:

Market makers help keep spreads tight. In a very liquid option (like Nifty weekly ATM), you might see just a 0.05 or 0.1 difference between bid and ask at times. That's because multiple market makers are competing, and plenty of volume keeps things efficient. If no one was making a market, you might find it hard to buy or sell without a big price concession

For far OTM or far expiry options where fewer traders are interested, market makers might widen the spread. You might see, say, ₹5 bid and ₹7 ask. That ₹2 spread is essentially their “fee” for taking the risk in a less certain contract.

How Market Makers Manage Risk:

If a market maker sells you an option, they don’t just pray it expires worthless – they will hedge. Commonly, they use delta hedging: after selling a call, they might buy a bit of the underlying (or futures) to offset directional risk (The Ultimate Guide to Understand Market Makers). They monitor Greeks – delta, gamma, vega – and try to keep a balanced “book”. Their goal is to earn small spreads repeatedly with minimal directional exposure. Of course, extreme moves or gaps can hurt them, but their sophisticated models price in those risks (that’s part of the premium they charge)

Why should retail traders care?

• Liquidity: Thanks to market makers, you can usually enter/exit positions easily in Nifty/BankNifty options up to fairly large sizes. The market is quite deep. Even if you’re trading something like a far OTM BankNifty call, chances are a market maker’s quote is why you see a price at all.

• Fair Pricing: Market makers keep prices aligned with theoretical values (plus a spread). If one option is mispriced relative to others, arbitrage by these players brings it back in line. So you’re likely getting a fair deal (assuming normal conditions) when you trade at market prices. It’s tough to “steal” an unfair price because the market makers will snap it up.

• Volatility Surface: Market makers also set the implied volatility for strikes by their quoting. The “volatility smile/skew” we mentioned is largely shaped by their pricing models (which incorporate supply/demand too). So, understanding how they think can help – e.g., they may demand higher premium for far OTM puts (fear of crash) which is why those have higher IV

  

• Slippage and Big Orders: If you place a very large order (say you want to buy 1000 lots of Nifty options), market makers will fill a chunk but might back off (widen spreads) as your order eats liquidity. They may dynamically adjust if they get too skewed. So big players often use algorithms to avoid spooking the market – essentially they try to trade like a market maker would, gradually.

Market Maker vs. You:

Sometimes retail traders feel “market makers are against us” – e.g., "the market maker ran my stop" or "they made the price jump after I sold". In reality, market makers are typically indifferent to direction; they care about balancing their books. But they do take advantage of irrational trades. For instance, if someone panic-buys way above fair value, a market maker will happily sell and pocket the edge. So, as long as you use limit orders and don’t chase, you usually trade close to fair value and the market maker's presence is helping you, not hurting.

Wrap-up:

Market makers provide the grease that makes the wheels of the options market turn smoothly. In India’s bustling index options scene, they ensure continuous trading. They earn from spreads and volume, while we benefit from liquidity. Next time you see a tight two-way quote on a deep OTM BankNifty option that you know no regular Joe is trading, you’ll know it’s likely an algorithmic market maker standing ready.

Finally, let’s dispel some myths and misconceptions that many newcomers (and even some veterans) have about options. It’s important to approach options with clear facts, not popular myths.