Big gangs, better prices

Vol #268 - April 9th, 2026

Sake takes a little getting used to.

The highest compliment I heard at a recent event was “this tastes exactly like I think sake is supposed to.” Mingling around and trying different expressions back to back gives you rapid fire exposure to the nuances of the various different styles. In my uneducated opinion, most were pretty mediocre.

Unlike wine where region is the major delineating factor, in Japan sake can be produced anywhere. What separates the different grades of sake is how finely the rice kernels are milled before brewing.

Sake rice is a much larger grain than traditional eating rice, and for premium grades of sake less than half of the original kernel remains. The more pure the starch center, the better it will interact with the koji, which is a mold-like substance that converts grains into sugars that the yeast can then turn into alcohol.

Traditionally this practice is done with long poles by hand, kneading the mixture like a ball of bread dough. Thousands of different breweries dotted the landscape and for more than a millenia after its discovery, sake was a very local tradition. Yet as industry advanced, the twentieth century saw the number of breweries collapse from 5,000 to less than 1,000.

Now almost two thirds of the production is in the “ordinary” category, where there is no milling requirement and healthy doses of brewer’s alcohol are also added. The consolidation of the industry means that the top ten producers account for roughly 40% of the volume.

While that sounds stark, in the beer world it’s even more concentrated - AB InBev and Heineken produce 39% of the volume between just the two of them.

And while my beverage colleagues all raised eyebrows at this stat, neither of these hold a glass compared to the consolidation in the equity options market making space.

The pictures of trading floors during their heyday are dotted with jackets of every color imaginable. A “local” could pull together a little bit of cash - as low as $50k - and find a backer who was willing to leverage their capital and take a percentage of the profits. Sole props provided a material contribution to the liquidity of large and small names alike.

Slowly individuals banded together. A couple of guys that trusted each other and wanted to hire a developer would form a trading group. Groups became firms who hired clerks and support staff. Firms became organizations that needed HR to police the unfettered raunchiness of instant messages and chat rooms.

Consolidation occurred at every stage, and now we have a half dozen highly specialized trading shops that dominate the dealer side of the trading world. Tens of thousands of customers come to the market every day, while only a handful of counterparties are there to take the other side.

There is nothing restricting an individual trader from gaining membership at an exchange and opening a relationship with a clearing firm. For the less administratively inclined, there are shops that specialize in this service, where a self backed market maker can stream quotes electronically and even raise their hand in open outcry.

But as with most things, it comes down to capital. It’s hard to build the flywheel of profitability and growth if you’re very constrained in what opportunities you can trade. Market making isn’t a prediction business, it’s a game of inventory management.

If someone is a good stock picker, they are on a fairly level playing field with the top names in that vertical. The $1,000 account compounds winners in very much the same way as a professional equities manager. It might be research desks versus message boards, but it’s basically the same game.

However market making is a business of providing liquidity to those who need it, and managing the risk of those positions. When a customer wants to trade a LEAP option that’s dated over a year in the future, the padding of all that uncertainty means there is often a solid amount of edge. But it takes a deep balance sheet to be able to warehouse that over the coming months, and a sole prop or even small shop might not want to take that on.

Even with near term options, the number of names that a smaller operation can trade is limited. While you’d always prefer that a buyer comes right after the seller of the same option, the flexibility to quote and price where there is trading opportunity is invaluable. Dealers can arbitrage time and space, but that requires deep pockets.

The evolving market structure is supported by and favors firms with very large footprints. As new exchanges spin up every few months, it not only takes development resources to wire up the connections, but there are ongoing expenses of membership and data feeds. Wholesalers who control the majority of retail orderflow are generally in favor of this as it creates new and different ways for them to process trades.

All of this sounds like a recipe for collusion. Which remains a very dirty word in the business, even though we’re 26 years past the infamous settlement with the Department of Justice. With fewer and fewer participants, don’t we land at oligopoly style pricing?

I would argue that the opposite is true. Because there are coordinated organizations with deep pockets, spreads get tighter and sizes get deeper because their economies of scale afford them the ability to offer better prices. With the regulatory backstops encouraging competition on auction orders and best price routing, even with only a few firms competing the customer ends up as the winner.

What a consolidation of firms does mean is a concentration of risk. There have been more conversations as of late about how all of this trickles down through clearing. Retail brokers have helped drive significant growth - particularly in short dated options - but the burden of funding the safety net at the OCC has fallen on other participants. And they’re looking to change that.

There’s a clearing risk when someone big goes belly up, but there are also operational risks to very large and significant participants. With each of these firms streaming billions of quotes, the smallest little error can have a ripple effect throughout the market. When Goldman Sachs was a large player they accidentally sent $1 orders in every security, roiling markets on the open and creating months of work to untangle all the “obvious” errors.

Consolidation also has some risks in terms of future industry direction. When the very largest participants have the ear of exchanges and regulators, they’re able to mold the landscape to favor their strengths. This could be a new crossing mechanism that favors initiators, or massaging the fee schedules to align with their routing preferences.

Most buy side traders get to benefit from consolidation however. While the risks are real, every single day price improvement and tighter spreads are very much the externality of the concentration of talent and capital in the market making community.

Dealers aren’t the only significant players in the market either. There are many participants who do just as much to provide liquidity and fair prices but don’t have the explicit registration status. Prices don’t stay in line because a market maker has a crystal ball about what skew or ATM vol should be - they move because orderflow drives them that way.

If you were on the floor of the CBOE or AMEX in the ‘90s, you’ll almost certainly be reminiscing about the good old days of trading elbow to elbow with several dozen of your frenemies in the pits. The spreads were a whole lot fatter, but volume was a lot thinner. There’s way more money sloshing around the listed options markets these days.

With art forms like sake or beer production, the decline of small operations is something to be concerned about. Craft processes benefit from small productions and the safeguarding of traditional techniques. It almost always produces a better product than the industrially brewed examples.

That’s not the case for traders and investors that use options. This is an industry where the concentration of expertise, combined with the deep pockets to manage inventory and spend on research and development delivers a decidedly better end product to the customer.