Here is a reasonably recent BOX filing if you want to better understand the overall concept. Preference liquidity has been around for a while and it's probably a fifth of the retail volume in non-monopoly products.
Sounds unspecific and mysterious without explaining what this means. Auctions are well documented. We also know how market makers work. So is your “liquidity” different from the details I’ve posted above about how/when/why option orders are filled? And does that hidden liquidity mean that someone is actively trying to buy/sell those illiquid options, or just making market?
It means there is hidden liquidity. A MM displaying a 5up market to the public over OPRA might want to be 20up for a preference brokerage house - but not show a 20up market for everyone. So they are working not get picked off. So I might be 20up for broker A while displaying a 5up market. It's not only the liquidity of the overall options but more about not shipping an order away under linkage and rewarding houses that send me flow. There is preferenced liquidity in even the most liquid names. It's about making deeper - non-displayed markets for my best customers and keeping paper off linkage for my preferenced(best) customers. Been around for more than a decade - look at the links in the PDF or search EDGAR. Not about price as much as depth.
Thanks, that's what I was thinking in terms of market-making computers being able to trade against orders close to the mid, but you put it more clearly, especially about them not wanting to get picked off. And of course they don't mind picking me off by giving me a worse price if I get too far away from the mid.
As far as I know, MIDPRICE orders are relative usually and not visible. So you're likely filled by other resting midprice orders or algos using it as an opportunity to scalp.
He mentioned options but according to IB they're not available for options, only stocks (so a different topic): https://www.interactivebrokers.com/en/index.php?f=36735
"IB traditionally wasn't a participant in preferenced liquidity, but that may have changed." I believe this had to do with them owning Timber back when they were created as their option destination.