NotQuiteRandom
Well-known member
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Lets use an example to try to explain.
Say Futures contract X is quoted in the market at 101 to 103. Thus you can buy at 103 or sell at 101 if you wish to take the market's price.
As a market maker you quote the 2 way price and hope to do enough business either side of the spread that you will, over time, earn as much of that spread as possible.
As a market maker you need to run a flat (no exposure) but this is not always realistic if you want to generate volume. So you will hedge as far as possible, sometimes by proxy in a correlated asset or, more often, in the same asset.
Lets say you, Mr. MarketMaker, are quoting 101 to 103 still but are net short, you may elect to move your 103 up to 104 to attract fewer buyers and your 101 up to 102 to get more sellers (to balance your book a bit).
While you are doing all this though the other market makers (and you) are also moving prices around as a function of supply and demand that comes across the other guys books as well as your own.
In essence you need a fast mind and a multi-factor model. It may sound a little fiddly but it is a great game.
Say Futures contract X is quoted in the market at 101 to 103. Thus you can buy at 103 or sell at 101 if you wish to take the market's price.
As a market maker you quote the 2 way price and hope to do enough business either side of the spread that you will, over time, earn as much of that spread as possible.
As a market maker you need to run a flat (no exposure) but this is not always realistic if you want to generate volume. So you will hedge as far as possible, sometimes by proxy in a correlated asset or, more often, in the same asset.
Lets say you, Mr. MarketMaker, are quoting 101 to 103 still but are net short, you may elect to move your 103 up to 104 to attract fewer buyers and your 101 up to 102 to get more sellers (to balance your book a bit).
While you are doing all this though the other market makers (and you) are also moving prices around as a function of supply and demand that comes across the other guys books as well as your own.
In essence you need a fast mind and a multi-factor model. It may sound a little fiddly but it is a great game.
Directional
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also not forgetting the exchange quoted calendar spreads. Both ES and YM have a fully fungible calendar spread and a back month. Much market making is done by quoting the front month with the spread and back month to hedge against or indeed, to cross the quoted trade out against.
Directional
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For example, if the front month is quoted as follows (hypothetical example):
......June 07 .............. Aug 07
.... 13327 offer ...........13249 offer
bid 13326..............bid 13247......
and the exchange quoted spread market was quoted as so:
June7/Aug7 calendar spread
........81 offer
bid....80......
An MM might try working the bid in the front month - in the example above if you managed to buy the bid at 13327 and got a fill, you could then sell the spread at 80 bid and sell the back month at 13247 bid to go flat.
The maths of this trade would be as so:
long June 7 at 13326 minus your Aug 07 short at 13247 = a difference (spread) of 79. Since you bought the front month and sold the back month, this would put you long the spread market at 79 and since the spread market is bid at 80 you could sell the spread in the exchange quoted spread market - so your were long the spread via the outright legs at 79, sold the spread market at 80 = 1 tick profit with "limited" risk..
A lot of the depth of market you see in the DOM ladder is derived in exactly this way since the market makers's can quote the market against the spreads and back month.
The downside is that the 1 tick will cost you four lots (front month + back month and spread counts as + two) which is why MM's pay uber-low or no commissions at all.
This example has the MM making 1 tick, but I suspect that much market making is done for the scratch and to turn volume, because exchange appointed MM's will usually get paid a percentage of the exchange fee per trade executed, so its in their interest to turn volume.
......June 07 .............. Aug 07
.... 13327 offer ...........13249 offer
bid 13326..............bid 13247......
and the exchange quoted spread market was quoted as so:
June7/Aug7 calendar spread
........81 offer
bid....80......
An MM might try working the bid in the front month - in the example above if you managed to buy the bid at 13327 and got a fill, you could then sell the spread at 80 bid and sell the back month at 13247 bid to go flat.
The maths of this trade would be as so:
long June 7 at 13326 minus your Aug 07 short at 13247 = a difference (spread) of 79. Since you bought the front month and sold the back month, this would put you long the spread market at 79 and since the spread market is bid at 80 you could sell the spread in the exchange quoted spread market - so your were long the spread via the outright legs at 79, sold the spread market at 80 = 1 tick profit with "limited" risk..
A lot of the depth of market you see in the DOM ladder is derived in exactly this way since the market makers's can quote the market against the spreads and back month.
The downside is that the 1 tick will cost you four lots (front month + back month and spread counts as + two) which is why MM's pay uber-low or no commissions at all.
This example has the MM making 1 tick, but I suspect that much market making is done for the scratch and to turn volume, because exchange appointed MM's will usually get paid a percentage of the exchange fee per trade executed, so its in their interest to turn volume.
