Suppose I place a market order to sell options contracts in a thinly traded market. Let's say the daily volume at a certain strike is five to 10 contracts. Is the market maker obligated to fill my order? -- W.L.

Right off the bat, let me say that I think poor execution and a perceived lack of liquidity are bigger obstacles for individuals looking to trade options than any difficulty in understanding their supposed complexity.

The short answer to the question is yes, you should be able get a market order filled at the bid price. But that answer needs qualification. Currently there are five options exchanges: the Chicago Board Options Exchange, the Philadelphia Stock Exchange, the American Stock Exchange, the Pacific Exchange and the newly formed all-electronic International Securities Exchange.

All require that the primary market makers or specialists maintain an orderly and liquid market. This includes providing a firm bid and offer in all their assigned options. Options on futures trade at commodities exchanges, and these exchanges use open outcry rather than market-maker systems.

Each exchange also has guidelines concerning minimum size requirements (the number of contracts available at a quoted market). For the most part, the goal of all the exchanges is to provide the public with a market depth of 10 contracts. Within that general rule there are specific conditions that would exempt the market makers from being held to filling a 10-contract order.

For example, here's

the text regarding depth of market rules on the Pacific Exchange. Note, the "10-up" requirement mentioned in the rules only applies to at-the-money and just-out-of the-money strike prices, and it can be waived entirely in "fast market" conditions. Also, public customer orders have priority over professional orders.

Distinguishing between bids or offers being made by the market maker and those representing broker or customer orders is important. There are maximum spread limitations -- the price differential between the bid and the offer -- to which market makers must abide. The maximum spread varies depending on the type of option (equity, index, fixed income, etc.), the expiration (near-term vs. LEAPS) and the price (at-the-money vs. out-of-the-money).

Generally speaking, the maximum spread allows increases with the price of the option and the length of expiration. These can be quite wide. For instance, it's not unusual to see a thinly traded equity option bid at $1.75 and offered at $2.25. Some at-the-money index options can have spreads of several dollars.

If a broker or customer order provides a better price (a higher bid or lower offer) than the market maker, that order takes precedence and is the prevailing market quote, regardless of its size.

So, to get back to the question, assume you want to sell 10 XYZ calls at the market price. If the market maker's spread for XYZ calls was $1.75/$2.25 you should be able to sell 10 calls at $1.75. But let's say before you enter your sell order a broker or customer places an order to buy two XYZ calls at $1.80. In that case, you will only be able to sell two contracts at $1.80. The market maker isn't required to buy the other eight at $1.80 or even $1.75.

In fact, after you sell those two contracts -- and this is where it can get frustrating -- you may now find that the market maker drops his bid to $1.60 or lower, even if the price of the underlying security hasn't moved. I should point out that the exchanges monitor and review market maker behavior, and if they determine that an orderly market and competitive bid and offer aren't being provided on a consistent basis, a market-making firm could have its status revoked.

My advice, then, is to use limit orders as much as possible, rather than market orders.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to

Steve Smith.