Adjusting the quote prices for a market maker
Suppose a market maker quotes a price and executes a trade. How should he adjust the prices given his current position, say he is 1 lot long?
Depends on your ability to process information from the market and the more you're ableto assimilate market activity, the better you'll know the mid market levels, which in return, you'll be able to service your clients better and capture spreads. Of course, you'll be competing with the traders on the same contract and to win the trade, you'll need to provide the best prices but at the same time, earn the spread from the mid price. The key to manage risk is based on your inventory level, deciding whether or not to warehouse the risk or to close it and this decision is based on number of facts... it could be market direction, liquidity (Let's say you're delta hedged and the underlying bid/offer widens and you decide to rebalance less due to crossing the spread), sentiment (Implied vol view, surface, skews risk reversals) or to ensure you're within your risk limits (gamma/vega/volga/vanna/sega/rega). Warehousing risk doesn't guarantee return, just a greater P/L volatility, hence risk limits must be in acceptable levels.
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