A market maker is a participant that continuously quotes both a bid and an ask price in an instrument. It provides liquidity to those who want to trade now and earns the difference between the two prices. In exchange, it carries the inventory that its clients leave behind.
How it works
The market maker sets its quotes around its estimate of fair value and adjusts them to its position, to volatility and to the flow it sees. On options, it rarely keeps directional risk: it delta hedges with the underlying or futures, and manages the remaining vega, gamma and skew across the whole book. On listed markets, designated market makers often commit to quoting obligations, such as a maximum spread, a minimum size and a minimum share of the session, in return for fee rebates or other incentives. On OTC markets, dealers play the same role on request.
Example
Hypothetical: a market maker quotes an option at 2.40 bid and 2.50 ask, multiplier 100. A client sells it 50 contracts at 2.40 and another client later buys 50 at 2.50. Ignoring hedging costs, the market maker captures 0.10 × 50 × 100 = $500. Between the two trades, it delta hedges the long position.
On the desk
The main risk is adverse selection: trading against a better-informed client just before the price moves. The spread exists to pay for that risk and for inventory, not as free income.
Educational definition. Worked examples are hypothetical. Not an offer or a recommendation.