You actually said "Markets exist for the benefits of hedgers / real-money players, and are arranged for their convenience.", that's pretty much saying markets are for "real hedgers", and semantics aside my point stands. If you change that to say you need a kernel of hedgers for a market for form around, then no-one would disagree with you, it allows arbitrage at the very least. However that's a very different thing than saying the market exists for them. There are actually a large number of markets where hedgers make up the minority of the market, for example less than 20% of the WTI crude futures market, so it's hard to say the market "exists" for that 20% and the 80% are merely "along for the ride". And look no further than single stock futures to see a world without market makers, ever try to trade one of those? And actually I don't generally agree to disagree on basic math. I could have 50 vertical spreads on 50 different securities that all added up to a 5% of my portfolio in total risk. And still not be able to take delivery on those if a significant number of them ended up ITM. No reasonable/sane person would call a portfolio where if all your positions went to 0 you'd lose 5% over leveraged, and I haven't seen you offer a reason why it would be. I'm not sure why you're so doggedly holding onto that view except that it was one you originally espoused, it just doesn't make any sense.
Mav, the SPX futures market seems to be perfectly fine and it's cash settled. I think opposition to cash settlements is less so in equity investors (probably because the market itself is a bit fictional).
Since you are apparently more experienced, I would love to hear how you would manipulate cash settled options...
I agree it's a much more important issue in commodity markets. However, I do remember some controversy awhile back with GS manipulating VIX settlements on expiration day by placing bogus bids in illiquid strikes for the purpose of skewing the final settlement.
Of course VIX futures have to be financially settled though! I've read that it's still somewhat trivial to manipulate VIX values a small amount, I'll have to look that up now that you refreshed my interest.
Naive question: what happens when I'm in the money with a phisycal delivery option and I haven't got enough money in my account for actual execution? Say I've got one call option with the strike price at $100, expiry is at the end of today and the spot price of the underlier equity is $150. The contract size is 100 but I've got zero cash in my account. With a cash settled option, I would make $5000. But with phisycal, what happens? I'm just losing my premium or worse, I get liquidated and have to eventually pay $10,000 for the delivery?
On the expiration morning, there is usually a fairly liquid market in front month variance which kinda makes manipulation attempts rather scary these days. That is, if you try to to change the strip (e.g. put in a bid), you can get done by someone who is trying to replicate the 30-day variance. I was only asking since you don't really come across as a guy with a deep understanding of the expiration dynamics and the market making process.