Can people opine on how market making actually works besides the simple bid ask spread explanation. How are you actually taking risk / analyzing markets / looking at fundamental value? Maybe a real life example with a thought process behind it. Thank you.
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Bump. Assuming markets are semi-efficient, and risk is priced into bid-ask spreads, am interested to hear how market makers are consistently able to generate the P in P&L.
as a market maker, you have a defined sector where you know the securities where you will be asked by customers to bid/offer.
that sector may be maturity based (5-7yr US treasuries) or companies (10 largest telecom company bonds) or credits (automakers CDS) or something similar...so you will live and breathe these securities.
As a market maker, you are thus expected to have a view on all the securities in your sector...and pretty much nothing else...so this is what you live and breathe...you read all the relevant research, stay up to date on various news items related to all the securities in your sector...and that itself is pretty much a full time job.
So, after having all that research complete, and having a view (both outright on the sector, and relative value amongst the various securities in your sector) you should now be comfortable to skew your bid/offer in the direction that positions you the way you want. Maybe you want to be long Ford and short GM...so you will skew your market bids and offers higher for Ford (100 bid, ask 101)...and lower for GM (95 bid, ask 96) (these are just made up numbers, for clarity) ...so when you are in comp with another dealer you will get hit more on your Ford bids (because you are bidding just a touch higher than the other dealers) and you will get lifted on your GM offers (because your GM offers are just a tad bit lower than the other dealers). And thus, you will leg into a long Ford, short GM position thru your customer market making activity. Now that you have the positions you wanted, and assuming you were correct and Ford prices move up, and GM prices move down (relative to each other), you now have an unrealized gain at mark to market prices, and so now you can unskew your bias, and try to exit your positions at a profit, and repeat the process over and over forever. This is the life of a market maker.
if however you were wrong, and Ford prices do not move up relative to GM in the timeframe you expected / are willing to hold the positions, then
(1) you may be forced to exit at a loss and your book will lose money
(2) you suck as a market maker and should be possibly fired if this continues and becomes a pattern
Is your example assuming that Ford and GM trade at a spread of like 98/99 typically or that Ford and GM are equivalent in the eyes of the market? If so then that all makes sense, otherwise it kind of confuses me. Let's say I want to be long Ford and Short GM, I'd skew the Bid/Ask towards the Bid for Ford so my bids get hit on Ford and I have a long position in my book and skew my Bid/Ask for GM towards the ask side for GM so my offers get lifted right so I have a short position in my book for GM? If I skewed Bid/Ask towards asking for Ford, people would be lifting my offer and I'd end up short shares of Ford. Or assuming both securities trade at 100 I'd offer a spread of like 90/102 for GM (exaggerated) to show I really don't want to be buying any GM here?
Let's say you're an options market maker vs spot equities. Is this where you'd be hedging your greeks right after you sell the option for typical sell-side firms and just trading vols? I understand a prop shop you can take more risk so when you're trading options is that where you can put your personal bias in and only cover a certain amount of delta/gamma etc? Let's say I sell a .50 delta put to someone as a market-maker but I have a long bias, I can choose to only partially hedge the position and have some delta carry that I can unwind later if I'm correct, or I could go completely delta neutral and get paid theta for being short gamma and just trade the volatility.
the bid is the lower price..the ask is the higher price....if you skew your prices towards the bid (ie. lower) then your bid won't get hit.
Also I saw you said there are unrealized market gains which all makes sense but I thought you are forced to sell on your ask offer not the “market price after the value goes up or down”
Yes, but you probably wouldn't have gotten lifted a bunch from your Ford position as your ask price was relatively high, which would enable you to build a sizeable position in Ford (as you're the top buyer in the market due to your high bid and a non-player seller due to your high ask), and presumably you'd adjust your bid-ask spread as Ford prices move up.
Thanks - I thought they say there are no human equity traders - it’s all programs - they reference the ubs desk vs. today
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