Options Exchange

What does an Options Exchange do in Options Trading?

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Options Exchange - Definition

An Options Exchange is a government regulated institution within which the act of buying, selling and settling options take place between interested parties and exchange members.

Options Exchange - Introduction

An options exchange is just like a stock exchange except that in an options exchange, options are being traded instead of stocks. There are 7 options exchanges in the USA in the year of 2010 and the most famous of all is the Chicago Board Options Exchange, CBOE. In fact, the CBOE is currently the largest options exchange in the world today.

So, what is the function of an options exchange? What goes on in an options exchange? Who are the people involved in an options exchange? How does options exchanges affect your options trading?

This free options trading tutorial shall explore these issues.

What Do Options Exchanges Do?

The basic function of an options exchange is to provide a marketplace for the trading of options. Due to this basic function of being the place within which options are traded, options exchanges have the responsibility for setting the rules of trading options, such as method of execution, conduct on the trading floor as well as the roles of each market participant. Some options exchanges are also responsible for creating and listing options contracts for trading by the public and will also set the parameters of these new options as well as create new forms of options.

All of these rules that each options exchange set can be found in what is known as a "constitution".

Components of a Typical Options Exchange

A typical options exchange is made up of the trading pits, regulatory body, exchange staff and computer systems. These come together in order to create a place where options can be traded in a fair and orderly manner.

Who Are Involved in an Options Exchange?

As you can see in the diagram above, a typical options exchange is operated by many people; Some of whom are involved directly with the flow of trades and some of whom ensures the smooth daily running in the background. Let's take a look now at some of the key staff that makes up an options exchange and how each of them affects your options trading.

Market Makers

Definitely the most famous and most misunderstood of all options exchange members. Market makers are who every options trader is trading with when trading options. There will be no options market without market makers as market makers are charged with the responsibility of creating a market for every options contract through an open bid ask system. When you buy an option, you are really buying from a market maker and when you sell an option, you are actually selling to a market maker instead of another options trader.

Read more about Market Makers.

Floor Brokers

Floor brokers are people who executes trades ordered by the public directly or through the brokerage firms they represent. These are the actual people who shouts out your orders and get them filled in a timely and diligent manner. There are floor brokers engaged by specific brokers and there are independent floor brokers representing a few different brokerage firms on a commission basis. There are two kinds of floor brokers engaged by specific brokers; The Pit Broker and Firm Broker. Generally, pit brokers handle retail orders (orders from you and me) while firm brokers handle large institutional orders (orders from big companies). Independant floor brokers typically pay for their own seat in the options exchange and handles orders both from the public and from various brokerages, making their income from commissions.

Runners

Runners relay orders and quotes between floor brokers and the firm booths in order to actually place the options orders ordered by the floor brokers.

Order Book Official

The Order Book Official (OBO) is in charge of enforcing the rules and regulations of an options exchange in the options marketplace. An OBO and Assistant OBO are also in charge of opening and closing the issues traded in the pits and filling the public order book.

Options Exchanges in the USA

There are currently 7 options exchanges in the US options market. In order of age, they are the Philadelphia Stock Exchange (1790), Pacific Exchange (1882), Chicago Board Options Exchange (1973), American Stock Exchange (1975), International Securities Exchange (2000), Boston Options Exchange (2004) and the Nasdaq Options Market (2008).

Do You Have To Choose Which Options Exchange To Trade Options With?

No, fortunately, you do not have to choose and trade with only one options exchange. Your options broker would automatically fill your order with the best match offered by all of the options exchanges.

Can't Decide Which Options Strategy To Use? Try our Option Strategy Selector!

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