'Teasing' Bids/Asks to narrow a spread by submitting/cancelling orders - what's this pattern called?

R

Rhiinoo

I notice this behavior all the time, so assume it's well-known and I just want to understand what I'm seeing / what's happening.

Consider an option with a fair value of $0.60 whose current spread is showing as: 240 x $0.50 / 325 x $0.90

Now suppose I put in a bid of 10 x $0.55 (and no one else joins me at that price) such that the spread is then 10 x $0.55 / 325 x $0.90

I've noticed that if I then cancel my Bid, the following happens:
  • The ask will dip down to 10 x $0.85 (so spread, for a few moments, is 240 x $0.50 / 10 x $0.85)
  • The ask size will then increase to a few hundred but stay at $0.85 (e.g. 240 x $0.50 / 325 x $0.85)
  • I can then repeat that sequence (submit 10 x $0.55, then cancel it), and it'll "pull" the Ask down to $0.80, then repeat it and the Ask will drop to $0.75, etc.
Now there IS a limit to how far I can pull the Ask downward like that -- e.g. in the example above for an option with a $0.60 fair value, I usually wouldn't be able to tease the Ask down below ~$0.70. I'm guessing this is just part of the market maker algorithm, but it's so reliably repeatable I'm just wondering whether it's well-known / what it's called.
 
Makes sense, thanks.

So you're saying that, in the example I gave for instance, the MM is just trying to be at the 'front of the queue' of $0.80 bids, in the hopes I ultimately decide to come up to that price level?

I should mention also that as best I can tell, there's no actual transactional advantage I can make of this situation...in that from some trial and error, I've found that the price I'm able to pull a MM's visible bid down to will still be there as a hidden Limit Sell price by that MM even when it's not displaying as the best Offer.

E.g. in the example above, if I could pull the spread Bid down to: 240 x $0.50 / 10 x $0.70, then even when the spread had initially been showing as 240 x $0.50 / 325 x $0.90, I could have put in a Buy at $0.70 and it would have gotten filled. So I suppose that that 'teasing' process has still served as an an effective way to figure out what a MM's best price would be even when the initial spread looks wide.
 
Rhiinoo said:
Makes sense, thanks.

So you're saying that, in the example I gave for instance, the MM is just trying to be at the 'front of the queue' of $0.80 bids, in the hopes I ultimately decide to come up to that price level?

I should mention also that as best I can tell, there's no actual transactional advantage I can make of this situation...in that from some trial and error, I've found that the price I'm able to pull a MM's visible bid down to will still be there as a hidden Limit Sell price by that MM even when it's not displaying as the best Offer.

E.g. in the example above, if I could pull the spread Bid down to: 240 x $0.50 / 10 x $0.70, then even when the spread had initially been showing as 240 x $0.50 / 325 x $0.90, I could have put in a Buy at $0.70 and it would have gotten filled. So I suppose that that 'teasing' process has still served as an an effective way to figure out what a MM's best price would be even when the initial spread looks wide.
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What if you made it a market order? That is their hope.
 
SoesWasBetter said:
its no bargain 99% of the time
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Yes, I didn't suggest it was a bargain of any kind -- hence my 2nd post where I say that I don't think teasing actually results in a better price than could be achieved without it...rather, all it seems to do is expose / give hints as to what a MM's 'best price' actually is.

Robert Morse said:
What if you made it a market order? That is their hope.
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Yeah, that was my assumption as well...that they just want to be at the front of the queue at that price level, either (a) when a buyer comes up to that level, or (b) if someone hastily- or unwisely submits a market order. (Though I have wondered in that latter case of a market order whether it would fill (using my #'s above) at the $0.90 displayed 'best Offer', or whether it might instead get filled at the MM's $0.70 best-but-not-displayed Offer, but I don't know the parameters of what order types they are using, and I don't place market orders, so I prob won't find out.)
 
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