Electronic market making
(Senior Chimp, 24
Points)
on 7/31/12 at 5:57am
Hi, could someone shed some light on what electronic market making is about? Is is a programming job or more of a trading job. Also, I have heard that more products will be moving towards more computerised trading. As such, is it fair to say that this area will possibly be expanding in the near future?






Yes. This might not be 100%
Yes.
This might not be 100% accurate, but this is what I think of electronic market making:
Let's say it's 1986 and you need to call a broker to place an order. You want to buy Jan '87 calls on XOM. Let's say XOM trades at 50 bucks right now and you think it will go to 55 by next january. The '87 calls with strike 52 cost $2.40. You call your broker and he says he'll sell it to you for 2.45 and buy it from you for 2.35. You buy 1 lot, for 2.45, but now your broker (the market-maker) is exposed to risk because if the stock goes up, he will lose money (he has to buy from the market and give you the stock for 52 no matter how high XOM's price is). The broker will have to hedge this by buying XOM stock on the spot or selling the reverse position (i. e. buying the call back) from someone at a lower price.
That was market making. Electronic market making is basically automating the whole process. There are loads of details. How do you forecast when the demand for a particular product will go up? If you think it'll go up, as a market maker, you'd want to load up on it so that you're there to sell to the demand. How do you efficiently match a buy order for a call with a corresponding sell order minimizing execution risk? How can you minimize unnecessary trades from your order book? Make sure you're never risking too much? Your bid-ask spreads are adjusted as the stock price moves? Is your option priced correctly? Will it allow arbitrage? Can you take advantage of this arbitrage efficiently to make sure the product is fairly priced?
All these problems can (or have to be) be tackled using programming. That said, market makers nowadays rely heavily on programming yes. There are some roles where you are to design algorithms to do this for you but you still need to know some programming.
I feel like this area will expand until there are no more traditional market makers/brokers left. There are a lot of products electronic MM is not applied in today. Like for example, electronic MM is starting to take over Fixed Income markets, tightening bid-ask spreads and making it harder to profit.
Feel free to correct me if I made any major flaw in that explanation ^.