How Does the Size of the Position Limit Affect a Market Maker’s Willingness to Quote a Tight Spread?

A position limit is the maximum net position (long or short) a market maker is allowed to hold in a specific derivative. A lower position limit restricts the market maker's ability to absorb large orders.

This forces them to manage their inventory more aggressively, often by widening the bid-offer spread to slow down order flow and reduce the risk of breaching the limit. Higher limits allow for tighter spreads.