I can leg into a spread manually by trading the legs, but what is IB or any other broker doing if I were to put in a limit order for the spread? Are they just automating the individual legs? How does this work with the giving and taking of liquidity on different legs? Are common spreads simply traded as their own unit?
There are 5 option exchanges with Complex Order Books. You enter the order as a spread to them. No Legging. AMEX, ARCA, CBOE, ISE and PHIX.
Initially the spread shows the combination of the individual legs. Then MM's can quote the spread itself separately, usually a lot tighter. Say it's a 9-10 put spread. 9-put = .10@.15 10-put = .40@.45 PS = .25@.35 If you would place a bid in the PS of say 0.32, the 10-put should show a bid of .42 and if that gets hit individually, your PS order hits the 0.10 bid in the 9-put. So I think your spread order would go in the individual legs orderbooks as well.. At least, on some exchanges... maybe not all...
A spread is traded as a single security (with no legs to be executed separately), so the mechanics of the limit order books, order placement, order queuing, order matching and order execution is the same as it is for the outright contracts.
I did not really follow that response. There are two general ways your spread orders are routed. Direct Market Access (DMA) or some type of "SMART" route. The DMA order goes directly the complex order book (COB) on the exchange you choose. None of those legs also go to any exchange as individual legs. SMART route orders don't have to follow any general rule. Our SMART routed spreads give a first look to a MM then it is represented on one of the option COBs almost instantly. The advantage to our SMART routed spreads is that you can avoid the maker/taker fees on equity options but still be exposed to the public on the COB.
I kinda tried to explain the mechanism if how an order would show up in the orderbook(s). As far as I know (limited to European markets) on some exchanges orders in the COB also change the bid/ask in the individual legs. Some don't... And, as an answer to OP's question re liquidity in individual legs... if MMs don't give a quote in the spread/COB, the bid/ask will show the combination of the individual legs. And when the legs change, so will the spread bid/ask.
In the US listed markets, they are separate order books. Very few traders "view" the COB, but they are monitored by automated traders and MM. MM don't make markets in the spreads unless there is order flow there. They are not required to. The CME (Futures) does have a RFQ, request for quote, for option orders and spreads, but the equity/option exchanges don't. There is no exchange mechanism for showing the legs. In fact, it is possible to be bidding for a spread that equals the NBBO and not get a fill. Especially if that bid and offer that makes up the NBBO are small customer orders that don't provide them an edge. You have to then execute your spread manually at the risk of the market to get done.