market making profitability
Market making has gone through several incarnations over the last two decades. The move from pit to screen trading in the late 90s to early 00s and subsequently automation of algorithms has seen some wildly profitable years for well positioned firms.
But in the last few years there has also been consolidation (eg. Knight, GETCO, Virtu, Timber Hill, etc) as the speed game was won and lost by various players. Curious to hear whether people think this line of business will be profitable going forward.
Going off publicly available data points, like Virtu and Flow Traders, seems that firms are still able to realize returns on assets of 20-30%. But the capacity constraints seems to indicate most of the shops do not go over ~1B in aum.
But I'm curious how do new shops compete?
Do they have to be specialists in certain product spaces, like ETFs for Jane St? Commodity futures for Akuna?
It seems most shops reach capacity by ~1B yet new shops still crop up (Akuna). Why is the space as whole still allow new entrants? And if it does allow new entrants why do the established players not increase their aum as there must be profitable trades out there they haven't taken advantage of, instead of limiting their aum?
People in the industry were predicting the demise of screen traders, yet I still see several shops thriving in the age of algos. How does an Optiver or SIG compete with Citadel or 2Sigma securities?
My hunch is that the realizable PnL in the space is fixed and its a zero-sum game. Why haven't the profits disappeared with all the new players? Why do firms still maintain 20-30% returns? I definitely don't think its a moat anymore as a lot of the hardware requirements are commoditized.
Hi coffeebreak, any of these threads helpful:
If those topics were completely useless, don't blame me, blame my programmers...
Also interested
Same
Incumbents get lazy and new guys do something innovative. There will always be money in it and then amount trends up as the market grows.
you say it’s zero sum but that’s far from the truth. I view it like a kind of waterfall.
At the top you have retail (in stocks or say producers in commodity’s) who effectively pour money into the market which eventually ends up hitting the bottom line of HFTs.
let’s take an example of a nice waterfall:
retail hnw in HK buys a structured product with some complex equity payoff for 1m$. Actual FV of that is 950k but the structuring desk has to hedge their risk. Structuring desk goes out in the market and hedges and doesn’t really care about paying bid/offer to the HFT market makers as they have a ton of margin anyway. HFT makes tiny margin but does it again and again.
fairs
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