There are two main types of investors in the options market: speculators and market makers. They trade in different ways to make a profit.

Speculators: Generally, investors who buy and sell a single option or create a trading strategy of multiple options in the market act as speculators. Speculators profit by successfully predicting movements in the price of an underlying asset over a period of time in the future, including an increase or decrease in the price of the underlying asset or the implied volatility (IV) of an option.

Market Makers: Market makers are typically large financial institutions that have contractually agreed to provide liquidity (that is, providing both bids and asks) to the market by continuously buying and selling options simultaneously.

Since options for an underlying asset generally have multiple expiration dates, each expiration date provides traders with multiple options for strike prices, and each strike price corresponds to a Call and a put option. Therefore, market makers need to quote a large number of options at the same time, which also provides liquidity to the market. This kind of market operation often requires strong risk tolerance, as well as the support of a large amount of funds, which is why market makers tend to be large financial institutions.

Unlike speculators, market makers profit from the spread between the bids and asks of an option. The price difference between the mid-price and the bid-ask quotation can be regarded as a reward for market makers for providing liquidity services to the market.

Because of the differences described above, speculators and market makers have different sensitivity to market prices. Speculators tend to seek greater profit between buying and selling on a single trade, while market makers are more concerned with how to profit from the bid-ask spread, such as the small differences between bid-ask prices on a large number of transactions. 

Market makers often need to manage complex and large positions, especially in the options market, which also makes market makers more sensitive to price than speculators.

Option Pricing

In the actual investment market, different types of investors don’t always play a singular role. When making quotations, market makers will not only take into account the underlying asset price and market volatility, but also their own holding positions and assessments of market movements. In bull and bear markets, market makers passively hold positions that oppose current market trends because they need to place buy orders and sell orders at the same time. For example, in a bull market, market maker quotes can be significantly skewed, resulting in higher ask prices for Call options and lower bids for Put options.

As you can see, there’s a certain competitive relationship between speculators and market makers. The price of options will eventually be formed by the interaction of various factors of different market participants. 

Tip

To learn more about options trading, and to more accurately assess trading opportunities, please refer to Introduction to Implied Volatility (IV) and USDC options.