Options Market

The Structure of the Options Market

The options market does not operate in isolation. It depends on a network of institutions and organizations that make trading possible, from exchanges and clearinghouses to regulators and brokers. The more you understand about this structure, the easier it becomes to navigate the rules, fees, and procedures that govern trading. The market itself is unpredictable enough; you don’t want to be caught off guard by administrative or regulatory requirements.

Naturally, every trader begins with a brokerage account, but the broker is only one participant in a larger ecosystem. Many other institutions contribute to the development of new contracts, ensure that trades are properly cleared, and enforce industry regulations. This system is not static. The financial services industry changes rapidly, with mergers, acquisitions, and new entrants reshaping the competitive landscape. As a result, details about which firms dominate may shift over time, but the underlying framework remains the same.

Pricing and Trading Structures

Competition among exchanges often centers on how orders are handled after brokers submit them. While this level of detail tends to matter more to institutional investors than to retail traders, understanding it helps explain how orders are prioritized and how fees are assessed. In the early days, orders were literally written into notebooks; today they are processed electronically, though the record is still colloquially called the “book.”

A key element of this structure is the role of the market maker. Market makers are members of an exchange who commit to posting bids and offers for every option series they cover. They may not have to match the price a customer wants, but they are obligated to keep the market active by ensuring there is always a quote. Some are independent traders, others work within specialist firms, and many are associated with brokerage houses. Their function is critical: they provide liquidity, create continuous pricing, and help ensure that options markets remain efficient enough for hedgers and speculators alike.

Because options trade in small increments, market makers operate in a high-volume, low-margin environment. Profits can be as little as a penny per contract, so the business depends on handling large flows. To manage their own exposure, most market makers hedge their positions elsewhere, which not only reduces their risk but also creates additional liquidity in related markets.

Order Handling

With countless orders flowing to the exchanges every second, a clear system is needed to decide which are executed first. Exchanges rely on several models:

• Customer priority gives precedence to public orders at a given price over market makers’ orders.

• Maker–taker systems exempt the liquidity provider from transaction fees while charging the taker of liquidity.

• Price–time priority fills the earliest order entered at a given price before later ones.

• Pro rata allocation spreads partial fills proportionally among participants.

• Size allocation favors larger orders when multiple orders compete at the same price.

While transaction fees are small—typically around 20 to 30 cents per contract—they add up quickly for large or frequent traders. Some exchanges also advertise price improvement, meaning the customer pays less or receives more than the quoted price. This often occurs naturally as markets move, but in some cases brokers can request auctions where market makers compete to offer better terms. For retail orders, price improvement is rare; it tends to be more relevant to large institutional trades.

Where Options Trade

Unlike stocks, which are issued by companies, options are created by the exchanges themselves. That means each exchange can design products with slightly different features or rules. In practice, once an option is listed on one national exchange, it can usually be traded on multiple others. These are known as fungible, multiple-listed contracts.

Today, options exchanges are electronic networks, not physical trading floors. Once upon a time, options pits were crowded, noisy spaces where traders in colored jackets shouted and gestured in the open-outcry system. That model faded, and the COVID-19 pandemic effectively ended what little remained of floor-based trading.

The Chicago Board Options Exchange (CBOE) was the first options exchange, founded in 1973, and it remains the largest and most influential. It operates several electronic exchanges, including the CBOE Options Exchange, CBOE BZX, CBOE EDGX, and the C2 Options Exchange. Beyond the CBOE, the CME Group runs multiple markets, including the Chicago Mercantile Exchange, CBOT, NYMEX, and COMEX, each specializing in categories such as equity index options, agricultural products, energy, and metals. The MIAX Options Exchange, founded in 2012, operates multiple platforms with different allocation models. Nasdaq runs six options markets of its own, each with its own priorities, while the NYSE offers options on equities and ETFs through its Amex and Arca exchanges. Smaller players like the Small Exchange and the Minneapolis Grain Exchange also provide niche products.

In most cases, retail investors do not select the exchange themselves—their brokers route orders to whichever venue offers the best execution at that moment. Some brokers allow clients to specify an exchange, but usually for an additional fee.

Over-the-Counter Options

Not all options are exchange-listed. Over-the-counter (OTC) options are customized contracts created directly between brokers and clients. These instruments are often referred to as exotics, since they may cover unusual assets or tailor-made circumstances. They rarely have secondary markets, and because of their bespoke nature, most individual investors will never encounter them. Still, they represent an important part of the derivatives landscape, particularly for institutions that need flexibility beyond what standardized contracts offer.

Choosing a Broker

While exchanges list and trade options, execution happens through brokers. Almost every brokerage firm offers options trading, but not every firm provides the same level of service. Casual investors might be satisfied with basic capabilities, but active traders often need specialized features such as faster execution, advanced charting, or the ability to handle high volumes. Many firms even market their options services under separate brand names, such as TD Ameritrade’s thinkorswim platform, to distinguish them from their general brokerage businesses.

Fees and commissions are one factor to consider, but they are not the whole story. Even if commission rates are low, additional costs come from exchange fees and execution prices. The true cost of a trade is the all-in amount paid or received, not just the stated commission. Brokers must publish quarterly statistics about their execution quality, which traders can review to compare firms.

Brokers also impose position limits to manage risk, restricting the number of contracts a customer can hold. These limits may be defined by raw contract numbers or by exposure measures such as net delta. For highly active traders, these restrictions can be just as important as fees or platform features.

Equally vital is the software platform itself. Since active traders rely heavily on what they see on screen, features such as real-time quotes, news feeds, technical charting, backtesting, and performance tracking can make a significant difference. Many firms provide demo accounts so prospective clients can test the platform with simulated trades before committing capital.

Futures Commission Merchants

Certain types of derivatives, such as futures contracts, options on futures, and swaps, cannot be traded through ordinary brokers. These instruments require access to a futures commission merchant (FCM), a broker registered with the futures exchanges. Many brokerage firms also operate as FCMs, but not all do. Anyone planning to include futures-based options in their strategy needs to confirm that their broker has this capability.

Agreements Required to Trade

Before a customer can trade options, two agreements must be signed. The margin agreement outlines the borrowing of funds inherent in options strategies and ensures the customer acknowledges the costs and risks of trading on margin. The options agreement goes further, confirming that the trader understands the risks of derivatives, the potential for significant loss, and the firm’s policies on exercise and assignment. By signing, the client also acknowledges receipt of the official guide to options from the broker, which contains all relevant disclosures. These agreements protect brokers from liability and ensure that customers are aware of the obligations they are taking on.

Other Institutions in the Options Market

Beyond exchanges and brokers, the options world has additional institutions dedicated to clearing, education, and regulation. The Options Clearing Corporation (OCC) is central to this structure. It guarantees that trades clear, manages exercise and assignment, and sets margin requirements. Clearing brokers, also known as clearing members, work with the OCC to handle settlement and provide account services, ensuring that obligations are met on both sides of every trade.

The industry also supports education through the Options Industry Council (OIC), a nonprofit group that provides webinars, courses, and publications for traders of all experience levels. Its mission is to improve understanding of options so that traders can use them successfully and continue participating in the market.

Finally, the industry is overseen by a complex web of regulators. The exchanges themselves establish rules for members and set standards for trading practices. Beyond that, government and self-regulatory bodies oversee different parts of the market. The CFTC (Commodity Futures Trading Commission) regulates commodity markets and thus plays a role in options on futures. The NFA (National Futures Association) works alongside the CFTC to regulate and license futures commission merchants. For equity and bond options, the SEC (Securities and Exchange Commission) provides oversight. Meanwhile, FINRA (Financial Industry Regulatory Authority), though not a government agency, regulates brokerage firms and their personnel under SEC authority. Together, these institutions maintain the integrity and stability of the options markets.