Dan Passarelli MarketTaker.com
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Here's the big secret: Market makers--the guys on the trading floor wearing funny-colored jackets who yell and scream all day--are actually risk averse. Who knew!?! Their real skill is in position management. Market makers set out to trade for "edge", which is attained by the ability to buy the bid and sell the offer. In the process, they end up with a position--often an unwanted position. The risk of the position needs to be managed. The market makers who succeed and prosper have risk management mastered while locking in edge from trading the bid-ask.

If market makers are making a trade, they want to have as little risk as possible. They'd be happy to trade for less edge if the trade has less risk. That's one reason market makers like trading spreads. Spread trades generally have less risk than outright option trades. In many cases, market makers are willing to trade a spread for less edge by trading between their market. In these cases, the trader (read: YOU) might be able to get filled at a better price.

For example, imagine a call spread that you want to buy is bid at .90, offered at 1.05. Often traders will simply buy the 1.05 offer. But, a trader may think about bidding somewhere in the middle of the bid-ask, say 1.00. In some cases, market makers will accept the bid and sell at the lower price. But not always.

While there's no way to know for sure if you will be able to get filled at a better price, one guideline is that you have a better chance if you meet the market maker at least half way. If you're buying, you need to be closer to the offer than the bid. If you're selling you need to be closer to the bid than the offer.

This technique, called "middling the market" tends to have better results with spreads than outright trades. Why? Two reasons:

1. From the trader's perspective, it can be a bit safer because spreads often have a smaller delta than outright trades. That means on the occasions that the trade "moves against you," they don't move as much as an outright option. For example, if a trader bids 1.00 with the offer being 1.05, the market may rise before the trade is filled forcing the trader to buy at a higher price. Smaller-delta spread trades move less, making that risk smaller.
2. From the market maker's perspective, because there is less delta risk (and less theta, gamma and vega risk), they are OK accepting less edge. They don't need to be compensated as much for their risk.

Dan Passarelli is the author of the book Trading Option Greeks and the president of Market Taker Mentoring LLC. Market Taker Mentoring provides personalized one-on-one mentoring for option traders. The company website is http://www.markettaker.com.

Dan started his trading career on the floor of the Chicago Board Options Exchange (CBOE) as an equity options market maker. He also traded agricultural options and futures on the floor of the Chicago Board of Trade (CBOT). In 2005, Dan joined CBOE’s Options Institute and began teaching both basic and advanced trading concepts to retail traders, brokers, institutional traders, financial planners and advisors, money managers, employees of the SEC and Federal Reserve Bank, and market makers. In addition to his work with the CBOE, he taught options strategies at the Options Industry Council (OIC). Dan has been featured on television and radio and has written numerous articles in the financial press. Dan can be reached at dan@markettaker.com. He can be followed on Twitter.