Can you explain me market making strategies?

So I was reading a book on markets and there I came across market making strategies. The author mentioned Ratio Trades and Flipping. Though I have gone over them I am still unable to understand.

Can someone explain these strategies with examples?

Thanks

 

For example, in the first scenario, consider the orders are filled on a pro-rata basis and the order book has a bid of 101 for a bid size of 1000 and an ask of 102 for an ask size of 20000.

Another scenario would be when the bid-ask spread is more than 1 tick. For example, same as the above scenario but with an ask of 105 instead of 102.

How would you implement a Ratio trade in the above scenarios?

 
Best Response

As Martinhoul has said, market making is to collect bid-ask spread, yes, I take some directional and RV positions but no trader on the street admits to taking prop and actually, my firm is pretty generous with our risk limits… I having a limited balance sheet, so I actually have little capacity to move the market and really, I’m at the grace of other people. The MOST important thing as a market maker is to manage inventory and that’s where your skill sets come in. The advantage that I have as opposed to liquidity takers is the spread, that’s it. It’s practically up to me whether or not I want to make a market and that’s probably the worst case scenario. I mean, you could make a market and usually, the best traders on the street will generally always make a market, even during times of great volatility, which is frightening. So in other words, cowboy up and make a market if you want to keep the shop alive. Throughout the day, you should ask yourself “how do I keep my profits”? You’re not there to make alpha generating trades. If you’re making a market, you’re making money, assuming you’re collecting spread if the midmarket price hasn’t changed. As a market maker, it’s absolutely crucial to keep the inventory within limits, it’s not about managing a strategy, it’s about managing inventory. Important stuff I ask myself when I’m on the desk is, how should I adjust my bid-offer prices, yes, I might make a mistake with a bid too high, but then I will take that into account and lower my bid. Ways you can address this is by adjusting based on your inventory. Having a big inventory is the biggest risk because you can no longer make trade or second if someone lifts my offer, my counterparty thought my price was too low and this is something I should take in effect.

 

As an Option MM, my job is collecting spreads + get out (hack) toxic trades/do more good trades. The former is done by managing position and reading the flow. If you think something is expensive so you are short but you only see buying flow, you should hack out some of your position because it seems obvious you can sell higher so u want to reduce your inventory. The latter is done by recognizing the pattern and tracking open inventories. If some kinda HF only sells vol and if you know they are pretty much right, you know what to do if they calls u for a market after vol got super pumped.

 

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