I sold a house in the DFW area in 2022. Instead of a mortgage, the buyers financed the purchase via a margin loan against their stock holdings held in a Morgan Stanley account. A bit unusual. That was the year mortgage rates spiked so maybe the margin rate looked relatively more palatable. But there could be other reasons too. For example, getting a loan or HELOC is much harder these days without a fat W2 income, so maybe the buyer was an entrepreneur or retiree.

[I remember the aftermath of the credit crunch, an oil option trader I knew just had an 8-figure year as an independent trader, couldn’t borrow even $2mm of the $5mm loft he bought because his income was deemed so variable. I’m not saying bankers should use a sortino ratio, but damn that was broken. The contrast of today, when every risk gets underwritten with little premium, to that era when banks wouldn’t touch cash-good risks is stark. Do what you want with that.]

We are going to start construction on an ADU so I’ve been thinking about financing at a time when there are more options (a pun that doubles as foreshadowing). Last week, I wrote a guide to option margin. While a post like that was overdue, the timing of it was not an accident. It is deeply entwined with today’s topic of disintermediated borrowing.

Box Spreads Go Mainstream

If you’re here, you probably know a box spread is a way to borrow or lend cash via the options market. A quick refresher from the lender’s point of view:

It’s a very vanilla option trade where you buy a synthetic long at one strike, sell a synthetic short at another strike, same expiration, and you’re left with a position whose terminal payoff is just the difference between the two strikes. Since you are both long and short the underlying for a known differential at expiry, that’s a profit guaranteed in the future. That future profit trades at a discount today because of the time value of money.

Since the profit is guaranteed, the discount rate is approximately the risk-free rate. In other words, it looks like a bond. You might pay $9.60 today for a riskless $10 in one year. In this case, you are lending $9.70 to the options market. The credit risk is minimal because, just like any option trade, you are facing the Options Clearing Corporation (OCC), not a counterparty or brokerage.

You can find a fuller treatment of mechanics in my post BOXX: Access Options Funding Rates In An ETF. BOXX was born around the time I wrote that article. Today, there is over $10B of assets in BOXX (I own some as well). Its success has had a ripple effect for consumers, creating an entire new financing market that is cutting out high-overhead banks by leveraging 2 innovations that are sadly not often recognized as innovations unless you work in finance:

• better risk-management
• liquidity

We jeered when the head of a vampire squid said he was doing god’s work, but Lloyd was being both cheeky and observant at the same time. But I agree, it’s hard to concede credit to a band of traders who somehow got made whole on their CDS while everyone else was forced to take medicine after the credit crisis. (This felt like Epstein class cronyism between gov’t and private industry revolving doors even before the unaccountability of elites became the issue it is today. In fact, that period felt like it got the ball rolling not to mention spread the ashes from which BTC would emerge. My crank sense of recent history is that the GFC is probably still underrated as far as what it did to any sense that we animals are created equal. Private gains with socialized losses probably revealed a US class system that hid for a long time behind a shared story. So long to that fairy tale. The spirit of the day is more like picking through the salvage bins for your own family’s needs while you watch the elites loot the trust that dies hardest because it’s rooted in desperate hope. Oops, that got out of hand fast.

Where were we? Ahh, yes, risk management and liquidity. The risk management part comes from the portfolio margin framework adopted by exchanges for margin accounts that opt into it. It’s explained in last week’s post, but it’s ultimately about looking at portfolios holistically and allowing for sensible offsets for analogous instruments. A call spread is a combination of 2 options, but the risk is well-defined if you recognize them as a single chunk. Asking for reserves that exceed the maximum loss is inefficient. Which means we can make the world more efficient by measuring better. I think we have enough computers to do that in 2026. Low-hanging fruit.

It’s hard to appreciate productivity gains like this because it’s not visible in the same consumer-friendly way as a phone with a camera in it. This goes for liquidity as well. If the inputs to pricing any risk become more transparent and measurable, then someone will require less premium to underwrite the risk. Pricing gets tighter, attracts more volume, more transparency and a virtuous loop repeats. It’s the gist of not needing to come to terms with finance guilt.

[As financial innovation goes, I’m not sure if the last PhD hired to provide best-in-class liquidity services has low societal ROI but the first one has a high one, and we can’t really know the limits. As freedom and competition go, the argument is best reserved for dorm rooms smoke-outs instead of pre-policy dossiers with a red hammer on the cover.]

Anyway, once a giant “lender” like BOXX pokes its beak in the options market, it attracts borrowers. Liquidity begets liquidity. For decades, box spreads have been a quiet financing tool for market makers and hedge funds operating under intelligent margin frameworks. They are now shaping a two-sided retail banking function. Without the banks.

 

The emergence of a retail box market

In early 2024, just months after BOXX launched the average daily notional volume on SPX box spreads was over $900 million. A year later, it had grown by 30% to over $1.2B. The CBOE has built an entire suite around the popularization of box spreads.

In addition to all the education (these are options after all), they’ve greased access to the box market via the Quoted Spread Book, launched June 2024. Cboe calls it QSB; I’ve always heard it as the “COB” or complex order book, which is the general way to interact with package orders in SPX.

Before QSB, market makers were not allowed to rest orders in SPX option COBs during regular hours forcing boxes and other complex orders to trade open outcry in the pit. Chicago is a gangsta town son. This effectively gated the market to those with a broker. Now, MMs can post electronic quotes in designated box spreads, box swaps and jelly rolls (calendar spreads of boxes used to roll from one expiry to another).

Each trading day CBOE designates roughly 10 box spreads and 25 box swaps as quotable with strikes in 1000-point increments. Since the option multiplier is 100, a 1 lot box spread corresponds to $100k value at expiration. You can think of that as the standard face value of the “bond”. A 10-lot would correspond to $1mm.

The borrower side of the trade

Pre-existing market participants create both the supply and demand for spreads in response to their cash management needs while BOXX is a structural buyer of boxes (a lending transaction) so long as it enjoys inflows.

The market is now seeing a new breed of borrower via sellers of box spreads. Historically, that borrower was a dealer financing options inventory. Increasingly, it is a wealthy household financing a house, a tax bill, or consumption. Given the endless bull run of equity markets, being wealthy almost certainly means sitting on a pile of unrealized capital gains. The economic impact of deferring or ultimately avoiding taxes is likely an order of magnitude higher than earning more market alpha. Eeking out an extra 200 bps of return per unit of risk is just not that interesting if you have to pay taxes on it every year, especially if you live in CA, NY, or Chicago, where somewhat ironically many alpha-obsessives tend to gather (notwithstanding large recent migrations to FL, TX, NV, and of course PR).

The reluctance to realize capital gains is the root of the “buy, borrow, die” strategy which revolves around funding expenditures with loans against appreciating collateral. Then, at death, the cost basis of the assets is stepped up to current market value when heirs can sell to pay off the loans. Rajiv Rebello’s Eliminating a Large Capital Gain with Tax-Aware Investing explains this as well as other increasingly popular tax alpha strategies. The common theme running through them is the use of borrowing/leverage to delay the tax man, hopefully forever.

Box spreads allow consumers with a healthy asset buffer to borrow at highly attractive rates, especially on an after-tax basis. Box rates typically print within 50 bps or less of treasuries of comparable duration. The “interest” you pay is realized as a Section 1256 capital loss, marked to market each year, 60% long-term and 40% short-term. Meanwhile, a margin loan at Schwab or a securities-backed line at a wirehouse can easily spread 200–400 bps over government rates. Depending on your personal itemization situation, the interest on those loans may be non-deductible.

The catch, of course, is that “all you have to do” to capture this is correctly execute a four-legged SPX option spread on an order book, understand margin against your portfolio, and roll spread before expiry. This is enough to keep most affluent households away, but this is changing.

White-glove vs. DIY

There are now broadly two paths.

White-glove

A handful of providers will run the strategy for you or for your advisor.

• SyntheticFi is the most aggressive on the retail and RIA side — YC-backed, run by Joseph Wang (ex-Deutsche Bank rates, ex-VRGL). SyntheticFI pitches itself as a sub-advisor that integrates with your existing brokerage rather than asking you to move assets. They handle execution and rolls and charge somewhere in the neighborhood of 50 bps on the borrowed amount
• Vest’s Synthetic Borrow is on Schwab’s Managed Accounts Marketplace and runs at roughly 95 bps. Managed box spread financing, advisor-distributed.
• Aptus is an asset manager with both option-based ETF offerings and an option overlay program which now includes box spread financing.

I’m not endorsing any of these but as I’ve seen box spreads awareness grow these commercial programs have made their way into my feeds.

DIY

As I alluded to earlier, if you have a portfolio margin account and feel comfortable executing option packages, you can do this yourself. You can even piggyback on SyntheticFI’s marketing efforts by using boxtrades.com (whose order book data is aggregated via SyntheticFi) to see daily and historical prints and rates by expiration.

The DIY route will save you 50–100 bps in fees in exchange for needing to handle the operations of trading, rolling and monitoring margin.

If you are interested in this route, I vibed up a handy checklist:

🔗Box Spread Borrowing: The Compact Guide

Home-financing angles

CBOE leads with this base scenario:

Instead of a 7% mortgages, borrow at the 5-year box rate of 4.5%. The “interest” on the box accrues annually as a 1256 capital loss, which you can use to offset gains elsewhere in the portfolio. A high-bracket household is financing a house at something with a 3-handle on it. From there, you can stack by taking a conforming or jumbo first mortgage up to the deductible-interest cap, then box-finance the rest.

Additional risk and other considerations

• The “jingle mail” option. A mortgage does have some unique advantages. It is a non-recourse loan.
• Margin call risk. Your portfolio is collateral. If SPX drops 30% the day after you buy the house, you may need to add cash, sell something, or roll into a smaller box. SyntheticFi’s published worked example has a borrower at 42% LTV able to absorb a ~40% portfolio drawdown before margin call. You are short a tail. Of course, you could also buy tails to cap your margin risk!
• Asset-liability mismatch. The box has a fixed maturity that is likely shorter than the duration of homeownership. You will need to roll, and the next box will print at whatever the curve is at that point. You have similar rate risks as an adjustable rate mortgage.
• Interest-rate risk on early unwind. If you need to close the box before expiration, you mark to current rates, which can be a cost.
• Realized interest costs. A simple rolling example could mean selling a new 1-year box for 96% of new face to buy back an old box at ~99% of face with 2 months left. The net out-of-pocket of 3% of face is your realized interest.

my little baby is all grown up

Before I go on, I just want to acknowledge how weird it feels to see box spreads become something a normal investor might hear about. When I was a trainee, the first option structures they taught were financing trades:

1. synthetic futures (or combos in the parlance of our time)
2. reversals and conversions which are just synthetic futures with an offsetting stock position
3. box spreads which are just spreads of synthetic futures (later you learn that algebraically they are equivalent to the sum of the call spread and the put spreads between the 2 strikes, an identity which helps you make markets in mock trading much faster!)

Despite some latent pangs of “I liked that band before you even heard of them”, the mainstreaming of box spreads makes a ton of sense.

Lending markets are normally intermediated by banks. The bank takes deposits at one rate and lends them out at a higher rate; the spread is the bank’s margin and the cost of the bank’s existence. The box spread goes around a costly bilateral transaction to let two market participants, one with cash, one with collateral, meet on a regulated exchange and swap exposures at clearinghouse-guaranteed rate.

Wes Gray, who co-created BOXX, told Brent Sullivan in Tax Alpha Insider:

Box spreads might be the ultimate ‘disintermediated’ borrowing mechanism out there.

The CBOE, fintech, and advisor community have found enough forgone bank margin to insert themselves as brokers between consumer borrowers and the liquid funding market entwined in the booming options business.

The wholesale financing rate that has historically been available to a market maker on the SPX floor is now accessible to a household with $2M in a brokerage account. These same households that are sitting on appreciated assets, which they can conveniently sell slowly in a tax-efficient way as the gains wash with the capital losses on the box “interest”.

Financial innovation and competition is notably triumphant in solving high-class problems. You can decide how to feel about that but I gotta figure out how to finance this ADU so you get to learn about stuff like this.

 

Further reading

• $1 Trillion Box-Spread AUM Is Up For Grabs (Brent Sullivan, Tax Alpha Insider)
• Long-Dated Box Spreads: A Better Way to Buy a Home (SyntheticFI via CBOE)
• How to Borrow at Rates Below 4% AND with Tax Benefits (30/40 Wealth)
• SPX Box Spreads: What Every Advisor Should Know (CBOE with Joe DeSipio at Arin, the ex-SIG team that sub-advises BOXX)
• Quoted Spread Book (Cboe market-structure docs)

A few quick hits to start

Welcome to Scamerica

I remember on the NYMEX, when certain brokers would mosey into the pit you’d literally hear someone say “watch your wallet”.

Well, here’s a new product from fintwit’s philosopher king:

My reflex was “Hey, here’s another fund using retail marks as exit liquidity before they can stuff the indexes with their low-float IPOs at mature, expensive growth valuations.” Thanks for the look Mr. Positive-Sum Game Preacher.

My expectations are so low for anything sold by the VC crowd on socials, but I still try to be charitable. Like, fine, give people what they want. You’re dying to pay trillion-dollar valuations in a one-way auction (see a recipe for overpaying), someone is going to broker it. Since it’s private and requires herding retail cats, it’s going to be pricey.

I also recognize I’m biased towards cynicism because when it comes to any match-making in finance. It’s a bazaar loaded with adverse selection because there’s so much info asymmetry and persuasive marketing within a competitive landscape that pretty much assures most of its emperors to be sociopaths.

But fine. It’s a market. It’s 2026. I’m inured against disappointment. In fact, flip it. The more fun game is to watch the limbo. How low we gonna go? Bro’s shoulder blades are grazing the turf. See the tweet:

Shout out to these guys for reading the fine print or at least feeding it to Claude. Oh the irony of using LLMs created by the companies in the fund to ask “read this prospectus and tell me all the ways I’m being bent over”.

Speaking of LLMs…

The agent craze has been amazing for getting things done, but in the past week I’ve needed to go back to the classic AI use — research.

A good friend from my local in-person life is raising a few hundred grand to grow a business he started a year ago that’s getting awesome traction. It started with him looking for a local business to buy but ended up with him starting one from scratch. It’s not a venture-shaped business and makes more sense for friends and family, so I am looking at it.

Over the years, I’ve invested in some private stuff friends have done, like restaurants or real estate deals. Some go well, some don’t. Honestly, the whole endeavor doesn’t feel like a great use of time so I’m definitely more disciplined about this stuff, but also I know I have so much to learn about business in general.

I have uselessly broad heuristics. SaaS is high margin. Packaged goods are about distribution. Bars are for vanity. I have a superficial understanding of accounting and financial statements from reading a couple books. But I do like looking at spreadsheets and following the cells to see the levers and sensitivities. It feels like a game.

And I took more interest in this exercise this time around as I looked through my friend’s financials for the past year and the model he built for projections and tracking. I think the extra interest is at least partly because of having to learn more about investing fundamentals for the class I do for the teens, but also because there’s so much less friction in learning.

For example, as I study his business, I can see how the gross margin shrinks down to the contribution margin and finally to a net margin. But then you wonder, how does this progression work in various business models? What are the typical ranges of relationships between the numbers across industries?

The questions come alive when you start from the specific, like a company you are studying, and then zoom out for perspective. You have to spend time on the company to start, but if you don’t have a background in banking, corporate finance, or accounting, you now have to build context. But this is where the LLM comes in. Especially the “deep research” or equivalent setting on whichever you use. The visibility of sources is an effective audit against hallucinations. And voila, you send it to work for an hour and you have a relevant book report customized to your practical interest.

I found its output satisfyingly illuminating for my purpose:

Contribution Margin Vs Net Margin: What Gets Lost Between The Two

My delight with that one renewed my interest in a book I printed out many years ago but never got around to reading:

The Base Rate Book Michael Mauboussin

I, of course, had the LLM create a summary with my interests in mind.

Again, more context for understanding business. On the one hand, stuff like this is high-level enough to only make you dangerous, but you have to build a sense of proportion and, well, base rates to relate narrow explorations, like that of an individual business, to enterprise broadly.

A word on AI book reports

I subscribe to a lot of quant finance substacks. I don’t read them all but the cost of triage with AI summary abilities is so cheap now.

But this is the mirror of the cheapness to produce as well. I have noticed that a lot of substacks with a premium tier are really just baity book reports about trading firms. Like long versions of twitter slop threads which are proven methods for building audiences.

I don’t want to be too negative about them since they do synthesize high-level information at slightly higher than replacement value than what you could wrangle out of an LLM. I usually don’t pay for them because they lack a sharp “point of view”. And even if they do, if it’s hard to tell if it’s an earned one, then it probably isn’t. God knows we’re awash in baseless points of view in general and that’s on the benign side of the spectrum, opposite rage-bait or doomer copywriting predation models.

I don’t have a grand opinion here, but I’m confident the future is going to be a lot more of your AI reading someone else’s AI-produced writing, at least in the world of non-fiction. Our relationship to reading is going to change and the role of email in that world will also transform. I need to think about this a lot more. My bet is that retaining a voice matters. The question is whether it matters the same way live music matters or if it’s looked at the way we see an artisan who makes their own furniture. Pure soulcraft.

Back to practical matters

In professional trading, there are critical functions that are abstracted away from your day-to-day job which cannot be if you are independent. A good example of this is the topic of margin.

If you run a strategy that is relatively small compared to your entire fund or firm so long as your haircut is commensurate with the opportunity size of your specific business, you likely don’t even know what it is. From your point of view, you’re trading with a blank check so long as you are within risk limits. Margin risk is monitored and managed a layer up from market risk which you are keenly aware of.

I’ve discussed this before in When it’s normal to have no idea what your returns are.

On the other hand, experienced retail traders understand margin inside out because it’s a matter of survival. Some retail traders understand it so well I think the margin sometimes wags the trading dog where instead of starting with an edge they start with what is margin efficient.

Margin and options is complicated topic and one I’ve been overdue on diving into. I put together a guide to understanding option margin, shorting details, and Interactive Brokers specifically since that’s my primary broker.

I host this on my Notion site. I used ChatGPT ‘deep research’ to do, well, the research then steered it into a reference, but something that should be read all the way through. Margin isn’t a fun topic but ultimately this is about risk.

Margin, Explained: Reg T vs Portfolio Margin, and Why IBKR Is a Different Animal

What you’ll find:

• Detailed look at both Reg T and Portfolio Margin (PM)
• A side-by-side summary of the key differences
• How each framework can hurt you in ways the other can’t
• Who each framework is actually best for
• How Interactive Brokers (IBKR) implements all of this differently from other brokers
• Short selling mechanics — borrow, SYEP, rebates — where IBKR is the unique retail player
• A glossary of the IBKR-specific metrics that actually matter (NLV, ELV, SMA, SEM, Excess Liquidity)

A few topics in here that were especially enlightening to me, often because they were discussed by different names than I’m familiar with or were not an issue in a professional setting.

Expiration risk

The first one here is one you will not encounter if you work for a firm but is dangerous for an individual. The idea that you can be liquidated on a long option! This scenario was one of the reasons I prioritized this article. A mutual on Twitter had this happen to them and discussed it on the timeline. There was a pile-on of “duh” but that risk is not something I’d necessarily focus on. Now I know better.

It’s an interesting risk because it creates a meaningful limit to how levered you can be on a long option position whose premium you can afford. For example, if you have a big chunk of your account in small delta puts that actually hit, you will likely need to roll or close before expiry and must be ready to trade.

1. IBKR runs expiration exposure simulations and may liquidate options before expiration if the projected post-expiry exposure is deemed excessive. Pre-expiration liquidations typically happen expiration day afternoon, sometimes earlier. IBKR may also lapse long ITM options that would otherwise auto-exercise if exercising would breach margin.
2. The truly dangerous case: early assignment on the short leg of a spread. IBKR will not automatically exercise your long leg to cover. Short put assigned Friday night → stock position Saturday morning. If you lack margin for that stock position, IBKR begins liquidating Monday at ~9:40 AM ET, and may liquidate any position in the account, not just the assigned shares. There are multiple documented six-figure retail blowups from exactly this.

Short selling

IB lets you lend your shares through its Stock Yield Enhancement Program (SYEP). You and IB split the lending fee charged to the borrower. But there are risks I didn’t know about:

• Loss of SIPC protection on lent shares. IBKR posts Treasury/cash collateral as a substitute, but in an IBKR default, this is your only recourse.
• Payment in lieu of dividends (PIL) when shares are on loan over ex-date: taxed as ordinary income (1099-MISC), not qualified dividend rates (1099-DIV). Practitioners report 50–60% of dividends received as PIL rather than qualified — tax disaster for dividend-focused portfolios.

IB’s advantage over many other brokers is that they pay you interest on the cash from the short sale proceeds (I was relieved to see that IB calls it what I’ve always known it as — the “short stock rebate”). The rebate is not as generous as what you get institutionally but it’s better than I got when I had a backer!

Final thought

The guide is critical for parsing whether you want to be in a portfolio margin or Reg-T margin account.

Unlike most Thursday posts, this one has a good chance of being more enlightening for professional options traders than retail option traders!

Trader is a broad term. Uselessly broad if it encompasses jobs from the Vanguard employee who sends the rebalance order 4x per year to keep VOO in line with SP500 weights to the oil trader who flies into contested lands to broker cargos to a warlord. The word “trader” flatters a healthy share of W2 earners while underselling big-stakes dealmakers. Trading itself is a business, capable of being traded, bought and sold, while the soldiers within the business themselves are also called traders.

The trading decision to bother at all with this project we call “trading” is more important than the trades you make if you do bother. This is why it’s important to understand the nature of the various careers that count as “trading”.

Market Makers

“Market-maker” is a weird word. The first time I ever heard the alliterative phrase was being asked in an interview to “make a market” on some quantity like “how many McDonald’s are in Philadelphia”.

Eyes just glazed over. Like what does that sequence of words mean? Like you want me to go make a market? Like set up a McDonald’s in Philadelphia? The words did not compute at all.

When I see a Asian HS kid with a swag tee that includes Jane Street’s logo in the sponsorship roll, I promise you that 16-year-old knows what a market-maker is. Times have changed. The job literally pays 21-year-olds the same amount a doctor makes by the time they are in their prime only after not sleeping in their 20s during the institutional hazing period known as residency. It’s the same pool of high achievers, but one group got the memo that being a millionaire by age 27 is better than just starting to chip away at a million dollars of debt if we count in pre-tax dollars.

There’s no twist here. Ball don’t lie. The market-makers have a sweet gig. That’s why it’s hard to get. Also, the kids they hire to become market-makers…well, they’re smarter than you. You can get all triggered and start the whole EQ or “street smart “ song and dance and you wouldn’t be totally wrong, but you’d be wrong. Those kids get hired because they’ve outcompeted many other kids who, unlike in my day, are aware of the job, aware of what it takes to get the job, and really, really want the job.

Now, if your goal is to be financially successful and you found this in any way to be discouraging, then you have told on yourself. Your powers of observation and creativity are holding you back more so than your brains. You’re also a quitter and may not have a claim to even a single original thought. Since nobody in their right mind would surrender to these charges, I assume nobody feels discouraged. We’ll proceed.

The point is, it’s a job with a honed criteria. On average, you must be tall to play basketball. No controversy. But this job of market-maker is just that. A job. You’re not an entrepreneur. You’re not consumer-facing. You aren’t a deal-maker. You’re a polar bear. Adapted to a specific environment. I’m not saying these people couldn’t adapt in another one, I’m only saying that they are specialists, which is a neutral statement.

The job doesn’t require as many hats as one that must constantly interface externally or with clients, suppliers, or investors. You just talk to other nerds and maybe, if you have a Chicago or Brooklyn accent, some brokers.

Which is all to say — it’s a weird thing to fetishize. If you’re going to fetishize a job just because it makes money, what happened to rockstars or center fielders or Scott Disick.

The fetish with market-makers or almost all professional traders is misplaced. Most professional traders have exactly what the dreamers don’t want. A job. They have a job in a system. With a boss. They are highly specialized at piloting that lucrative system, but it’s not their system. A fighter pilot is a decent analogy. You have an exceptional person tuned to commanding a complex, cutting-edge machine. You want a great pilot to maximize its potential. But if we’re being honest, the machine matters more. If you have a 2.5 standard deviation pilot instead of 3, I suspect that doesn’t matter as much as having the best jet. If you’re a market maker whose machine can’t win a race, it won’t matter that you’re smarter than the trader at Jump.

Unless…

You’re not entering the battles or the races where the machine is the showcase. The traders who have the biggest p/l’s don’t necessarily get to keep the most, because they are the same traders who had the fastest plane. Well, a lot of that performance is credited to the tech. The seat.

Since I left institutional trading, I’ve had a chance to meet traders I didn’t think existed. I’ve been paid to simply be a sounding board for people who have more money than they have any idea what to do with. Money piled high by trading for themselves in active strategies. Sums that pods would be thrilled with, but this is personal capital. Those are the traders I’d think would be in the mind’s eye of the aspiring trader. No obligations to investors. Very few or even no employees. The trading versions of Phil Ivey.

[I don’t think I’d be stepping out of turn to share some commonalities I noticed in my conversations with these traders. They were all under 35. They were almost all obsessed, although some were leaving that phase. Having more loot than you can spend in a few generations is probably demotivating to anyone who isn’t a megalomaniac.

Which leads me to what I did not expect…they were all humble. It wasn’t an aww shucks humility. It came across in the way they listened. Sponges. Parsing everything. When I say humility, I mean low ego, as in they didn’t bring assumptions to the way they listened. It felt out of the ordinary and yet they all shared this quality. It left a mark on me. Since meeting them, the absence of this quality is now more noticeable.

Oh, one amusing contrast. There was this recent Pmarca bit where he shit all over introspection, meanwhile, I recall this group of traders being way out on the right tail of introspection and self-awareness. Could be a selection effect as I was approached by a 3rd party about meeting them, so I wouldn’t meet the people who didn’t agree to it.]

Anyway, back to the market-makers toiling away in their getting-paid-like-a-doctor-in-the-80s job. They’re not raising a flag, but by virtue of their academic excellence and persistence, have successfully landed, at least a temporary inheritance, of a lucrative seat. The seat is a legacy from a process I outlined in A Former Market Maker’s Perception of PFOF:

What’s absent from the narrative is how tall the pile of bodies these firms stand atop. I should know. I used to be able to work five hours a day (NYMEX alum holla) and make a lawyer’s wage. And in some years, a law partner’s carry too. Well, if you were smart you saved your money and realized it wasn’t going to last. The days of “locals” (ie wildcat market-makers) is long gone.

Many of the small firms, who saw the writing on wall and had an appetite for the long game, plowed money back into massive technology capex. Most of them just earned the right to say they lost to the best. In some cases they found small, profitable niches where they play the role of suckerfish. Respect to them, even this was not easy.

How about the remaining firms? The private giants the media likes to call “shadowy”. They were the ones who were most adept at assembling teams of software and hardware engineers working with game-theory geniuses to devise algos in a cat-and-mouse battle with competitors. The ones who stayed step-for-step with the exchanges who themselves were experimenting with matching engine rules, data, product listings and connectivity in their own battles for market share.

The truth is progress is cutthroat.

It started with skill and luck. The early big bets on talent and technology meant they were bringing guns to a knife fight. SIG wasn’t know as the “evil empire” on the Amex just because of the black jackets we wore. They understood the risk-reward was completely outsized to what it should be 25 years ago. They were amongst the first to tighten markets to steal market share. They accepted slightly worse risk-reward per trade but for way more absolute dollars. They then used the cash to scale more broadly. This allowed them to “get a look on everything”. Which means you can price and hedge even tighter. Which means you can re-invest at a yet faster rate. Now you are blowing away less coordinated competitors who were quite content to earn their hundreds of percent a year and retire early once the markets got too tight for them to compete.

SIG was playing the long game. The parallels to big tech write themselves. A few firms who bet big on the right markets start printing cash. This kicks off the flywheel:

Provide better product –> increase market share –> harvest proprietary data. Circle back to start.

The lead over your competitors compounds. Competitors die off. They call you a monopoly.

Option market-making is not a monopoly but an oligopoly since a handful of firms control a vast majority of the market share. Oligopolies tend to emerge in industries where high fixed costs are a barrier to entry.

Options market-making derives its high fixed costs from technology capex and the need for extensive market coverage. You can’t price options competitively in a thin margin game if you cannot see and connect to flow. You need both speed and breadth. If you can’t price well and access uninformed orders, then you only get filled when you’re wrong.

All the talent, pipes, compliance, quoting infrastructure, data, and regulatory overhead have to be procured and maintained whether you trade one contract or a million. Whether the VIX averages 9 or 29 for the year.

This is all easily apparent to anyone who’s been around the industry. But I’ll add a more editorial thought. Exchanges are the archetype for a business with “network effects”. They are expensive to build and maintain, but the biggest hurdle is the chicken-or-egg problem of attracting liquidity.

Unfolding today, in the wake of Hyperliquid’s great success, there’s a swath of perp exchanges trying to grab a foothold. 10 exchanges aren’t gonna make it…but it’s a lotto payoff for the winner(s). Spoils to the victor of the tournament. Spoils in the form of excess profit. Network effects mean wide moats for incumbents. These are businesses that are closer to monopolies.

I was at the NYSE and the NYMEX before they each “demutualized”. They went from being member-owned organizations that were thought of as utilities to public companies. The incentives shifted from the desires of member firms who had trading permits to public shareholders listening in on quarterly earnings calls.

This is America. What have you done for me lately? Where’s my 15% annual growth? And not only do I want the growth, I want the put. Give me consistency. Well, conveniently for exchanges, some of their biggest customers are those steady oligopolies. You want them to be happy. You want them to be good credits.

At some point, the marginal benefit of allowing an additional market maker’s ability to effect pricing in hopes of growing the pie is not worth destabilizing the symbiotic equilibrium the exchange maintains with its existing market-makers, especially as volumes hum along.

In the past 25 years, we’ve gone from 4 option exchanges to 18. Some of these have been spinoffs from incumbent exchanges. Some have been backed by the market makers themselves. You can make Friedman-esque justifications for these investments such as “customer choice”, but it’s also the standoff at a drug deal. Every investment is another gun drawn, maintaining both the tension and stability of the current equilibrium.

As we zoom in from the industry point of view to the day-to-day business of filling orders, we find the rules of engagement which inherit from the higher-level negotiated equilibrium. A mix of privilege and obligation. This is the environment in which those who become market-makers slot into when they accept their “trader” job.

From this point, we launch deeper into the privileges that accrue to these market-maker seats regardless of who sits in them.

 

On The Trading Floor

I started on the American Stock Exchange (AMEX) on Trinity Street. It was one of the 4 option exchanges back in 2000. The AMEX was a “specialist” system. Specialist is a technical title granted to a firm on a per-symbol basis by the exchange. It confers a set of rights and obligations to a primary market maker. For example, SIG was the specialist on the AMEX for IBM options.

The specialist was in charge of broadcasting electronic quotes to the world. Market makers would “stand in the crowd” in front of the IBM post and announce their own markets, ie bids and offers, for the different option series.

If a market-maker and specialist disagreed, they could trade with each other. If there are no disagreements, the broadcast market was the aggregation of the best bid and ask from the market-makers and specialist. In the case of a multiple-listed option, for example, IBM trading on the CBOE, the agglomeration of best bids and asks is known as the NBBO (national best bid/offer).

It is hard to find a picture of what this looks like on the web, I had to dig this up from the AMEX Alumni Group on Facebook.

Floor brokers would receive orders from trading desks and investment funds, walk over to the post, and either request a quote or expose their bid/offer. If they announced a bid or offer, this is now legally public information. It was not public before it was vocalized. Similarly, an electronic order is not public until it routes to the exchange and is represented on the order book. A specialist had a waterfall view of the orders arriving and had to represent it to the crowd so that the market-makers, the specialist, and any broker in the crowd had an opportunity to fill it inside the NBBO. If they chose not to, the order if it could, would be matched with any customer bid or offers resting on the order book. At those prices, the resting customer orders had priority over market-makers but any imbalance could be filled by the traders, routed to another exchange, or if there was no marketable opposing order, it is left to rest unfilled, assuming it had a limit. Market orders, of course, always find a price.

Notice how much optionality there is in standing on the floor. You get the right of first refusal. Even more subtly, you get access to tells. If a broker buys IBM calls, then approaches the crowd again, you might guess she’s a buyer. You see the same people every day. You start to notice patterns. Today, people program computers to spot patterns. Then you could see the order urgently sprint or leisurely stroll into the crowd. The benefit of all this is bundled into the general term “time/place advantage”. We will come back to this, to see how it persists today.

This advantage is not free, but it was available to anyone with sufficient capital (low 6 figues was sufficient but not advisable) to fund a margin account with a clearing firm and either buy or lease a seat. You also had to pass a membership exam to make sure you knew the floor rules. There are lots of rules about how orders have to be handled, communication conducted, and general compliance. The test was about as hard as the Series 3 but not nearly as hard as the 7.

In addition to time/place advantage, specialists were entitled, depending on conditions to 30-40% of the volume that traded on the published markets after any customer orders were satisfied. The market-makers in the crowd had to split the remaining 60-70% (I might be a bit off on those percentages; it’s been a while). Some crowds were chill. Some were cutthroat. It wasn’t common, but things could be fisticuffs tense over whether that 40% meant rounding up or down a single contract of an order in something as juicy as an index option that trades by appointment. Also, where you physically stood in the trading crowd could easily mean the difference between hundreds of thousands of dollars per year. Standing close to brokers or being cozy with the specialist was the original co-location.

[Random aside: I met a buddy of mine who had a similar career path, although he came up through Knight/Citi back in the MSFT crowd on the Amex. Really nice guy, a year younger than me, also Cornell. He got assigned to market make in that crowd a few months after I joined it. We were both pretty young in that group and looked out for each other as much as we could in the context of working for competing firms. Somewhat recently, he told me a story of how I got into a nose-to-nose shouting match with a broker who tried to bully him when he was new and he never forgot that I stood up for him. I don’t even remember it. Which goes to show that confrontation, despite being uncommon, was still way more routine than most jobs.]

In exchange for time/place and allocation advantages, specialists were expected to maintain “orderly markets”. This means being willing to quote all the option chains for each name assigned to your post (this could easily be 40 stocks). All the strikes, including the deep-in-the-money high delta strikes, where you are more likely to get picked off if your model has the wrong underlying price because the bid-ask in the stock goes wide. There were guidelines about how wide you needed to quote based on how risky the stocks were. The privileges outweighed the burden provided you had enough know-how to price options and navigate different market conditions.

If you were too weak or meek in your liquidity provision duties, the exchange could re-assign your specialist post to another firm. The exchange was sensitive to market share. They wanted strong traders who could price tightly to lure flow away from competing exchanges once options became listed on multiple venues, breaking any single exchange’s monopoly.

The upshot of this storytelling is that option market makers exist at the intersection of statutory privilege in exchange for obligations set at a high bar. If the bar is too low, privileges are granted without a commensurate improvement in market quality, however you care to define that. If the bar is too high, then the privileges are not worth pursuing.

Wherever that bar is set, one thing is certain — the fairness or anti-competitiveness of its product will be debated. Which is fine, but as you’re about to see, the statues are esoteric. It’s not discourse you are used to hearing about. And behind every rule, there is a winning and losing lawyer, both of whom were paid by extremely rich clients.

Let’s examine some privileges, shall we?

[A note on the research: I relied on Claude’s Research Mode to surface citations, but I only chose to focus on items that were salient to my business. I pre-applaud your masochism. This is like reading Warhammer rulebooks.]

I’ll classify the privileges into 2 categories

Moats: Barriers that keep non-MMs from competing away the margins. These barriers have costs.

Time/place advantage: execution advantages that directly generate P&L

Moats

The Professional Customer Classification (The 390-Order Threshold)

If you are a market-maker looking to leave the mothership and start a hedge fund that tries to be a market maker, you might wanna be aware of the “390 rule”.

Any non-broker-dealer customer who averages more than 390 orders per day during a calendar month loses “Priority Customer” status and gets treated as a “Professional”. You are then queued behind Priority Customers and stripped of customer-level fee treatment.

💡Why 390? That’s an order a minute for the 6.5 hours the market is open.

In addition, cancel/replaces count as new orders, complex multi-leg orders may count each leg separately, and brokers must review customer activity at a minimum quarterly and reclassify within 5 business days, while ISE requires aggregation of “obviously connected” accounts to prevent splitting orders across multiple accounts.

The practical implication:

Most obviously, you cannot just stream a 2-sided quotes as if you are a market maker. More subtly, being cast a “Pro cust” loses Priority Customer allocation priority and are treated the same as broker-dealer orders. For the people who did trade on the floor, you might remember the provision that allowed you to not honor your quote for an order that came from a professional broker dealer. The “390 rule” rhymes a bit.

Also, the 390 threshold hasn’t been adjusted since inception despite the explosion in order volume.

Fast pipes

Market makers pay for and receive preference for faster pipes. This enables effective market maker “protections”. For example, if you get filled on too many contracts over a small time interval, or take on too many deltas too quickly, the protections kick in and “panic” your quotes (ie widen them way out) because there’s a good chance you’re getting picked off by. Lots of execution software have the ability to tune these settings but they’re only as good as the pipes they operate on.

Portfolio Margining & Capital Relief

Risk-based margin using OCC’s TIMS framework. Qualified traders get roughly 6.6-to-1 leverage vs Reg T’s 2:1. For registered MMs, FINRA Rule 4210(a) allows margin on whatever basis is “satisfactory to both parties,” with the binding constraint being net capital haircuts under Rule 15c3-1.

Ultimately this rule gives prime brokers room to innovate on how they account for risk and feels less heavy-handed and more market-based. But it’s something outsiders are less aware of.

DMM Seat Concentration & The PFOF Loop

This is one I wasn’t aware of exactly but Claude surfaced. Would love if any readers can verify. It’s esoteric but important since the most desirable flow to trade against is usually less than 15 contracts or so.

DMMs receive the first 5 contracts of any order at exchanges where they hold designation. Exchanges almost never reassign DMM seats. This combines with PFOF to produce a self-reinforcing loop: the DMM pays PFOF to brokers, brokers direct flow to exchanges where that firm is DMM, and the DMM captures the guaranteed allocation on that flow.

I thought there were internalization mechanisms that would supersede this but again open to learning.

Reg SHO Locate Exemption

When an options market maker needs to sell stock short to delta-hedge, they are exempt from the requirement to first locate shares. Instead market makers receive an extended close-out window of T+4 under Rule 204.

If the market-maker fails to deliver:

• on a standard short sale, it must be closed out by the beginning of trading on T+2 (one settlement day after the T+1 settlement date).
• in the course of “bona fide” market making, they receive an extended timeline of T+4 (three settlement days after the T+1 settlement date).

FINRA has intensified scrutiny on this issue. The 2025 Annual Regulatory Oversight Report warns that merely having an exchange’s market making designation does not per se qualify for the exception. A new reporting requirement as of Dec 2025 will give regulators order-level visibility into which short sales invoke the MM exemption.

Claude identifies the “locate exemption is the single most economically significant MM privilege”.

There used to be a time when the window before your shares were “bought-in” was 13 days. I was strictly in the futures markets in those days but I heard of strategies where MMs would cover then short again to reset the clock. You can basically get away with buying synthetic stock via combos way at big discounts in hard-to-borrow names without getting hit with the big financing fee on the short leg of the arbitrage.

No first-hand experience here, so treat this like gossip.

Position Limit Exemptions

This one was a pain in the butt as a large option trader in USO but without market maker status.

Standard position limits are tiered at 25,000 to 250,000 contracts based on the net delta option positions.

When USO was a $20 stock, 250,000 contracts amounted to about 5000 WTI futures options contracts which isn’t a huge position when you trade a few thousand lots a day. I can remember needing to build a tool that wpuld compute how many USO options I could trade on one side of the market if a broker showed me a deal. “Well, I got this many expiring Friday, so next week I’ll be able to do the trade, sorry”. I’d even look into trading rev/cons just to free up capacity in case a juicy trade came along I would have enough regulatory lot overhead to do it.

Meanwhile exchange-registered MMs are exempt from the limits.

Time/Place Advantage

Guaranteed Allocation / Priority in Order Matching

On most options exchanges, designated/primary market makers receive a guaranteed percentage of incoming order flow when quoting at the best price — independent of how many others are also at that price. This is reminiscent of the specialist or designated market maker system (the CBOE doesn’t have specialists; it has DMMs).

Current allocation rates by exchange (again according to Claude):

• Nasdaq ISE: PMM receives 60% (one other participant at best price), 40% (two others), 30% (more than two). Precedence on all orders of 5 contracts or fewer.
• NYSE American Options: Specialist guarantees of 40–60% depending on the number of controlled accounts on parity.
• MIAX Options: PLMM receives the entire allocation of orders of 5 contracts or fewer when quoting at NBBO.
• Nasdaq PHLX: Directed Order Flow Program allows up to 40% participation when quoting at NBBO.
• Cboe Options: DPMs/LMMs receive priority through pro-rata allocation combined with the marketing fee pool.

   

Exchange crosses and “QCC”

The time/place advantage that makes upstairs traders throw their turret through their monitor is the floor market-makers’ right to “break up a cross”.

This is best explained with a scenario.

Let’s say the consolidated screen market for the USO June 100 put is $6.20-$6.90 25×25.

The screen is only “25 up” meaning that’s the full displayed size on the NBBO.

A broker has a customer who wants to pay $6.75 for 1,000 lots.

The broker “shops” the order, calling upstairs option traders, funds he knows are active in the name, or even some commodity market makers.

He gets a hold of me.

I agree to sell 1,000 at $6.75. The client is happy, the broker gets to charge both me as the “solicited order” and the original client commission (the broker is said to have “double billed”— at $1 per contract the broker makes a quick $2k).

High fives all around.

Just one more step. The trade has to be “printed” on an exchange to go on the public tape before it can be submitted for clearing.

Well, the market-makers on the floor know I was solicited to “cut” the market. Even though they are offered at $6.90 on the “wire”, they want to sell at $6.75, especially knowing that the “solicited seller” who is probably a vol trader is offered there. It’s a pretty good trade to sell on someone else’s offer!

So the market makers have a few choices. They can wait until the broker starts announcing the trade, remember the broker needs to represent the bid and offer aloud by announcing “$6.75 bid for 1000, at $6.75. Trades”. Then, market makers pounce, hitting the bid when he announces it. My solicited offer goes unfilled, the broker only gets to bill the original client, and has an unhappy seller on his hands.

This is all quite adversarial and risky. It goes down like this in fiercely competitive crowds. But the normal way this happens is in the context of a repeated negotiated game. The broker understands the market makers have the right to “break up the cross” and the market makers understand that if the broker doesn’t bring flow to this floor as opposed to another, they’ll never eat.

So they haggle.

The market makers might say we’ll let you cross 600 contracts but we want to sell 400. The broker says his solicited seller won’t go for that and he’ll “take the order away to another floor to cross”. The market makers relent, “fine we’ll settle for 20%” and the deal prints.

The market makers have a large advantage. They get the last look. They get to know the solicited trader’s intent. And finally, they get a crazy “free roll”. Let’s say USO tanks in the window of time between when I agree to sell the puts and the broker representing the orders to the floor. The put fair value might jump up to say $7.00 and the market makers not only pass on selling puts but they decide to jump in front of the original customer order and lift my offer paying $6.80. This would be a disaster for the broker. The original client is unfilled and now the puts have run away from them, while I, the solicited offer whom the market makers perceive as a competitor, get picked off. The broker has 2 unhappy customers. Realistically, the broker wouldn’t open themselves up to such a fiasco (although sometimes they happen…there is an amount of money where an iterated game becomes worth sacrificing for single windfall).

You can see how powerful this market maker time/place advantage is. It’s so strong that in the last few years, Citadel started putting market makers on at least the CBOE. SIG always had market makers on every floor so the broker cannot threaten to “take the order away”. SIG is going to make sure it gets its tribute.

Now there are mechanisms for crossing option trades electronically. It’s known as a Qualified Contingent Cross (QCC). It allows the broker to cross the trade without exposing the options leg to the normal auction process, but it must meet specific criteria:

• The order must pair the customer’s options order with a stock order; delta-neutral ratios are common.
• It must be at least 1,000 contracts on the options side.
• The package is crossed at a price that’s at or between the NBBO.

The rule was designed for large institutional hedged trades where breaking up the package would create execution risk, as I described above. The idea is that the stock and options legs are economically contingent. You wouldn’t do one without the other.

The QCC mechanism eliminates the floor traders’ last look advantage but only for orders that meet the criteria. For a live (ie unhedged) option order, you are forced to expose it to either an electronic auction or a trading crowd.

Going from memory, most QCCs print on the PHLX, as they targeted this volume with rebates or monthly fee caps, but again, don’t quote me on that. Even when this is your job, it’s a task to stay on top of all the changing fee schedules.

If you want even more detail, I stepped through some examples in a chat with Jason:

Wrapping up

The romantic notion of being a “trader” exists, but it’s a small percentage of those who identify with the title. Market makers are traders who are deeply embedded in a system of privilege and obligation. They operate within an optimization and constraint function that is relatable only in the abstract and incomplete way that any business you are not fully in is.

If you put different people in the same seat, you’ll get different results. But it’s not the absolute p/l that matters, but the VORP. There’s a y-intercept to that seat’s p/l that derives from technology and access that wouldn’t exist at another firm. You can think of the y-intercept of profits like operating margin instead of p/l.

If you don’t believe me, eavesdrop on a manager giving his trading pod henchmen a year-end review. You’re a special snowflake when they recruit you, but a commodity when they pay you.

Hey, at least you didn’t have to take the MCAT.