Suppose a market on a liquid option chain is 0.01 by 0.02. Customers place orders to buy at the bid. Order type a limit day order at 0.01. Customer is charged if s/he cancels the order, and typically leaves it till end of day if not filled. Broker forwards the orders to a market making (MM) unit/organization. Instead of filling the customers' orders, MM does this: 1. Buy for itself what it can at 0.01, but at any point in time, its net position (long) never exceeds the amount requested by customers on this option chain. 2. Place for sale at the ask what ever it has bought at 0.01. 3. Steps 1. and 2. are running simultaneously. If the ask price falls to 0.01, then the MM offloads on the customers at zero risk. Could this happen? It seems to me that for a MM the above is a zero risk strategy and the MM would be willing for pay half the gains from this if the MM is not part of the brokerage firm. My example is for a 0.01/0.02 liquid option chain. Such chains exist. A problem here is that the customer may never get filled unless when the ask price falls to 0.01 or the MM decides to offload by end of day any inventory that was not sold at 0.02 by end of day. In any case, the customer may be taken advantage of. Could the above happen?
No, this doesn't really happen. First, the MM would have to buy .01, but as you know, customer orders are executed before mm's. So, if someone sold .01 then the customer will buy it first. The only way the mm could buy .01 is through a cross on the floor or bid .01 on other exchanges where there aren't customers that are .01 bid. MM's will 'lean' on books and hedge around large orders to make $$, they play that game and so does everyone else.