Interview w/ Former Market Maker & VP at TradeStation

In this episode, we sit down with Adam Cohn, Vice President and Head of Trading Operations at TradeStation, an award-winning trading platform known for its comprehensive trading tools, advanced charting capabilities, and extensive market analysis features.

Adam brings a wealth of experience, not just from his role at TradeStation, but also from his extensive background in options trading in the Chicago pits and as a market maker. His deep understanding of market structure and dedication to best execution have made him a trusted figure in the industry.

In our conversation with Adam, we discuss trading operations, market structures, and the complexities of order execution. You’ll learn about order routing and execution, what factors determine fills, payment for order flow (PFOF), the role of market makers, and so much more.

This episode is a must-listen for options traders looking for a deeper understanding of trading options.

Order Routing & Execution Basics

When a trader clicks "send order,” the broker’s system first validates whether the client has the necessary funds or assets to execute the trade (pre-trade validation). Once validated, the broker decides on the best venue (either an exchange or a market maker) based on a routing algorithm that optimizes for price, speed, and liquidity.

When routed to an exchange, the order will likely be filled at the best available bid or ask price shown on the exchange. It does not account for potential price improvements beyond the displayed price.

Market Makers typically have more flexibility, as they can offer price improvements by filling orders at a better price than the visible bid/ask.

After routing, the market center evaluates the order and executes it based on its criteria, often completing the entire process in 20-30 milliseconds for equity orders and up to 200 milliseconds for options orders.

Finally, the broker updates the trader’s account, and a notification confirms that the order was filled.

How volatility impacts order routing

The rapid processing speed ensures that orders are executed almost instantaneously, but during periods of high volatility, factors like liquidity and spreads can influence the final execution.

Volatility spikes and market opening/closing tend to widen spreads and reduce liquidity, which impacts the speed and final fill price of trades. During times of volatility, market orders might receive less favorable fills due to rapid price changes and higher bid-ask spreads.

Order Filling Dynamics

The primary factors involved are:

Liquidity at the quoted price
The size of the order relative to available volume
The specific ticker or market being traded.

Large orders, particularly those that outsize the quoted volume, are more likely to be partially filled or experience delayed execution. This is especially true in less liquid markets.

Tip: Traders should consider breaking large orders into smaller batches or using limit orders at multiple price points to improve their chances of full execution.

Market makers act as liquidity providers and counterparties to retail orders, offering price improvements within the quoted bid-ask spread. They also offer better fills than direct exchange routing, particularly during low liquidity periods.

Example: A market maker might improve a $0.05 - $0.15 cent bid-ask spread by offering a fill at $0.10 cents instead, which a standard exchange order might not capture. They may take the opposite side of a retail order and use hedging strategies to balance risk across other positions in their portfolio.

Payment for Order Flow (PFOF) and Market Structure

PFOF is a compensation model where brokers receive small payments from market makers for routing orders to them. This allows brokers to offer commission-free trading to clients.

Although PFOF has reduced trading costs and improved liquidity for retail traders, concerns exist around its influence on order routing decisions.

Pros: Reduced or zero trading fees for retail clients and potentially better execution quality from market makers.

Cons: Potential conflicts of interest if brokers prioritize PFOF over best execution quality.

Alternative sources of liquidity do exist, such as dark pools.

Dark pools are non-public trading venues where large blocks of shares can be traded without displaying quotes. They are often used by institutional traders to minimize market impact.

In the context of options, dark pools are less relevant due to the market structure's highly transparent and “lit” nature.

Challenges & Technical Issues

Challenges include handling large order volumes, managing latency, and ensuring accurate execution quality during periods of high market activity.

Routing to the best venue becomes especially challenging during extreme volatility, as rapid price changes can cause system congestion and delayed executions. During sudden volatility spikes, the sheer volume of orders can overwhelm brokerage systems, causing technical glitches and order delays.

While this creates the perception of a rigged market, it’s often a matter of system capacity and latency rather than intentional manipulation.

Regulatory Landscape and Future Outlook

Recent Securities and Exchange Commission (SEC) proposals aim to introduce new order-by-order auction requirements and change tick sizes, which could slow execution times and alter how retail orders are handled.

If enacted, these changes could disrupt the current best execution models by forcing orders into mandatory auctions, leading to higher latency and potentially poorer fills for traders.

With no finalized rule yet, traders should monitor the SEC’s movements closely, as significant shifts could impact the efficiency of current trading strategies and the cost structure of trading.

Best Practices for Traders

Patience is key: There is always another opportunity around the corner! Waiting to get filled after a good price is better than accepting a poor price. Forcing trades can lead to negative outcomes.
Use limit orders: Avoid market orders, particularly in options trading, as they can result in unexpected prices, especially in thinly traded markets.
Monitor liquidity: Place orders in highly liquid options contracts (at-the-money and near-term expiration) to increase the likelihood of fast and full fills.
Gradually adjusting limit prices can help achieve fills without compromising on price. Avoid the temptation to switch to market orders too quickly. SmartPricing works through the bid-ask spread, automatically sending and canceling timed limit orders so you don't have to monitor and adjust orders manually.