As a Market Maker, when do you adjust your spreads?

[76132]

During market making, when would you adjust the spread of your bid/offer? Obviously you adjust the price points of your bid/offers based on new market information, but when do you adjust the spread?

Do you adjust the bid/offer spread when someone posts a spread that is narrower than yours, thus forcing you to narrow your spread if you wanted to trade. For example, if I am 2 at 7, and some guy comes in and is like 2 at 6, in order for me to sell my product, I'd have to match or beat. So I'd have to go 2 at 6 or 2 at 5.

Would the opposite apply to? If I'm at 2 at 7 and the next best bid/offer is 2 at 10, shouldn't I increase my spread to 2 at 9?

But are there any other reasons as to why you'd adjust your spread besides how active you want to be in the market? If I didn't want to trade today, I could just go 0 at 1,000,000 or something.

And what happens if someone does post a spread that is narrower than mine, or provides an offer price that is lower than my offer price? What are they thinking and what should I watch out for? Could that imply that they have inside information?

Thank you so much for the help!

 

[emg]

u will not get a straight answer. it is a secret. If u want answer, u should work for the house. After all, that is where successful traders begin their career instead at home subscribing 3rd party vendors thinking they have a holy grail system

 

[dumb_mother]

depends on if you want to make money now or throughout the day- for me if i'm willing to do -3 / +3 if it gets near and hits me i'm happy. i mean there was a reason i was willing to do those prices to begin with and hopefully that reason holds true

 

[76132]

Quote from dumb_mother:

depends on if you want to make money now or throughout the day- for me if i'm willing to do -3 / +3 if it gets near and hits me i'm happy. i mean there was a reason i was willing to do those prices to begin with and hopefully that reason holds true

By -3/+3 do you mean that you are 3 points below the best bid and 3 points above the best offer?

 

[nitro]

[Option] Market Makers adjust their spreads based on the amalgemation of three (or more things)

a) Supply and Demand
b) Their current position
C) Current Market made by other MMs

So if you see lots of call buying, at a certain part of the curve, you might change the curve at that point. So lots of ATMs going off, maybe your raise vol if it is demand, and vice versa. If you have a position, you might change your parameters to get you out at a profit [lots of ways to do this, box, etc]. If other MMs change their markets, you might decide to join if you think it is a smart market maker.

I don't really know how equity market makers make their markets. That just seems based on inventory, but it might follow a similar logic to above.

Quote from 76132:

During market making, when would you adjust the spread of your bid/offer? Obviously you adjust the price points of your bid/offers based on new market information, but when do you adjust the spread?

Do you adjust the bid/offer spread when someone posts a spread that is narrower than yours, thus forcing you to narrow your spread if you wanted to trade. For example, if I am 2 at 7, and some guy comes in and is like 2 at 6, in order for me to sell my product, I'd have to match or beat. So I'd have to go 2 at 6 or 2 at 5.

Would the opposite apply to? If I'm at 2 at 7 and the next best bid/offer is 2 at 10, shouldn't I increase my spread to 2 at 9?

But are there any other reasons as to why you'd adjust your spread besides how active you want to be in the market? If I didn't want to trade today, I could just go 0 at 1,000,000 or something.

And what happens if someone does post a spread that is narrower than mine, or provides an offer price that is lower than my offer price? What are they thinking and what should I watch out for? Could that imply that they have inside information?

Thank you so much for the help!

 

[76132]

Quote from nitro:

[Option] Market Makers adjust their spreads based on the amalgemation of three (or more things)

a) Supply and Demand
b) Their current position
C) Current Market made by other MMs

So if you see lots of call buying, at a certain part of the curve, you might change the curve at that point. So lots of ATMs going off, maybe your raise vol if it is demand, and vice versa. If you have a position, you might change your parameters to get you out at a profit [lots of ways to do this, box, etc]. If other MMs change their markets, you might decide to join if you think it is a smart market maker.

I don't really know how equity market makers make their markets. That just seems based on inventory, but it might follow a similar logic to above.

Thanks so much for the response! I was actually interested in Options Market Making so this was really helpful, albeit confusing since I'm trying to learn this on my own.

Could you tell me what a 'smart' market maker is?

Also, I was wondering if you could tell me if my translation of your main paragraph is correct?
"...certain part of the curve..." - different strike prices within a single expiration I presume, or could you be referring to different expiration dates of the same strike price?
"...lots of ATMs going off..." - lots of people buying At the Money options?
"...raise vol if it is demand..." - does this mean to raise implied volatility by increasing the price?

 

[nitro]

Quote from 76132:

Thanks so much for the response! I was actually interested in Options Market Making so this was really helpful, albeit confusing since I'm trying to learn this on my own.

Could you tell me what a 'smart' market maker is?

You tend to know who the main MMs are in a given stock. Some market makers completely shadow the main MM.

Also, I was wondering if you could tell me if my translation of your main paragraph is correct?
"...certain part of the curve..." - different strike prices within a single expiration I presume, or could you be referring to different expiration dates of the same strike price?
"...lots of ATMs going off..." - lots of people buying At the Money options?
"...raise vol if it is demand..." - does this mean to raise implied volatility by increasing the price?

The first and most important thing to understand is that options traders assume an efficient underlying. They trade delta when it is to their advantage, but mostly trade delta-neutral.

You tend to treat each month expiry separately. There are at least three things that most options traders agree on, each deals directly with a specific mathematical construct of the pdf : the overall level of the Curve, the "tilt" of the curve, and the wings of the curve.

The overall level is adjusted by raising/lowering the ATM vola, and the rest of the curve makes a parallel move up/down. This is the standard deviation. The "tilt" of the curve is how steep or not it is, otherwise known as skewness. The wings are DOM options, and reflect the kurtosis of the distribution. By playing with these three parameters, the entire curve is then fit to smoothly derive the entire curve, which then become your mass quote. Most autoquoting software allows you to move nodes up and down individually as well. As the underlying ticks, the curve is recomputed.

This is a simplification, but it is 85% there.

 

[Bakinec]

Quote from nitro:
The overall level is adjusted by raising/lowering the ATM vola, and the rest of the curve makes a parallel move up/down. This is the standard deviation. The "tilt" of the curve is how steep or not it is, otherwise known as skewness. The wings are DOM options, and reflect the kurtosis of the distribution. By playing with these three parameters, the entire curve is then fit to smoothly derive the entire curve, which then become your mass quote. Most autoquoting software allows you to move nodes up and down individually as well. As the underlying ticks, the curve is recomputed.

This is a simplification, but it is 85% there.

That's too simple for him, IMO. You should throw in there a couple more abbreviations and market slang.

 

[76132]

Quote from nitro:


The first and most important thing to understand is that options traders assume an efficient underlying. They trade delta when it is to their advantage, but mostly trade delta-neutral.

Hey, thanks again for the response. I've read or actually skimmed (it was hard to absorb/understand everything) through Allen Baird's Market Making book, and he mentions that options traders do tend to stay delta neutral. He also mentions always staying vega positive. I was wondering if this was true for actual market makers and in reality, do most market makers stay vega positive? If that is true, would you say some form of the long butterfly strategy is most commonly used to stay vega positive? Would you also see long straddles or strangles here and there - I don't think MMs use these two but I don't know why not?

Quote from nitro:
The overall level is adjusted by raising/lowering the ATM vola, and the rest of the curve makes a parallel move up/down. This is the standard deviation. The "tilt" of the curve is how steep or not it is, otherwise known as skewness. The wings are DOM options, and reflect the kurtosis of the distribution. By playing with these three parameters, the entire curve is then fit to smoothly derive the entire curve, which then become your mass quote. Most autoquoting software allows you to move nodes up and down individually as well. As the underlying ticks, the curve is recomputed. [/B]

Let me try to translate it to see if I understand haha.

With some software, you can make parallel shifts of your mass quote (which reflects what you think the probability distribution of the underlying asset's future price is) by just moving the price of the ATM option. However, you can also change the skewness or kurtosis of the curve by changing the prices of the different 'nodes' or strike prices.

So I guess the thought process goes like this:
As you receive new market information, your outlook on the price of the underlying will change. This change affects what you think the probability distribution of the future prices of the underlying will be, which changes what you think the implied volatility of the option should be. Based on what you think the new probability distribution will be, you adjust the prices of your options at the different strike prices accordingly.

While this is going on, you also have to adjust the spread of your bid/offer based on the 3 factors you listed before.

With all this stuff going on, how much room is there for game theory, i.e. if another MM has prices listed that are different from yours, what may he be thinking? Do traders have time to factor that into their decisions? Do MMs compete intensely against each other?

Thanks again for the responses. They are very helpful!

 

[cvds16]

a lot has to do with your 'inventory' although that definition is wider than what most people would think, it's both inventory in individual strikes, in calls, in puts and in vol. These things will all make a difference in how you want to price. Always vega long is personal preference but one which a lot of market makers have because your risk or ruin is diminished by a great magnitude. With vega short you might not survive to trade the next day if some disaster happens. All the above is a bit of a simplification, but that's basically it. A 'smart' market maker doesn't necessarilly copy the main market maker but moves his own prices according to the changes in his 'overall inventory' as his bid or his ask becomes 'first' he will get more likely hit in that side, so either he goes back to his previous pricing accordingly with the 'main market maker' or the main market maker will move according the new prices as his inventory gets skewed. It's simply supply and demand. There are days when vol-trading almost seems a one way street and you have to adjust all day long to keep your inventory somewhat balanced. There is a lot of math, but also an 'art part' in reading supply and demand and acting accordingly. When I used to trade options I used to hedge my delta within 5 seconds.