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Large Option Trades, Market Makers, and Limit Orders

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  • Berkman, Henk

Abstract

This article focuses on the difference between market makers and limit orders in their role as suppliers of liquidity. For both sources of liquidity I analyze the price behavior of stocks and options around large option trades and I estimate the premium paid by the initiator of the large trade. My findings suggest that limit orders for options are "picked off" after adverse changes in the underlying stock price. Furthermore, I find that for these transactions there is a permanent change in quotations in the direction of the transaction. After transactions where market makers supply liquidity, quotes tend to return to their pretrade level. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Berkman, Henk, 1996. "Large Option Trades, Market Makers, and Limit Orders," The Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 977-1002.
    • Handle: RePEc:oup:rfinst:v:9:y:1996:i:3:p:977-1002
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    Cited by:

    1. Kapetanios, George & Konstantinidi, Eirini & Neumann, Michael & Skiadopoulos, George, 2019. "Jumps in option prices and their determinants: Real-time evidence from the E-mini S&P 500 options market," Journal of Financial Markets, Elsevier, vol. 46(C).
    2. Fahlenbrach, Rudiger & Sandas, Patrik, 2005. "Market Frictions and Seemingly Anomalous Co-movements of Index Options and Index Futures Quotes," Working Paper Series 2005-10, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    3. Jonathan E. Alevy & Michael S. Haigh & John List, 2006. "Information Cascades: Evidence from An Experiment with Financial Market Professionals," NBER Working Papers 12767, National Bureau of Economic Research, Inc.
    4. Liu, Wai-Man & Sawyer, K. R., 2003. "How free are free trading options?," Pacific-Basin Finance Journal, Elsevier, vol. 11(5), pages 573-591, November.
    5. Fong, Kingsley Y.L. & Liu, Wai-Man, 2010. "Limit order revisions," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1873-1885, August.
    6. Silva, Ana Cristina & Chavez, Gonzalo, 2002. "Components of execution costs: evidence of asymmetric information at the Mexican Stock Exchange," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 12(3), pages 253-278, July.
    7. repec:feb:framed:0003 is not listed on IDEAS
    8. Liu, Wai-Man, 2009. "Monitoring and limit order submission risks," Journal of Financial Markets, Elsevier, vol. 12(1), pages 107-141, February.
    9. Aitken, Michael J. & Berkman, Henk & Mak, Derek, 2001. "The use of undisclosed limit orders on the Australian Stock Exchange," Journal of Banking & Finance, Elsevier, vol. 25(8), pages 1589-1603, August.

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