What techniques to market makers use to manage operational and 'massive' adverse selection risks?

[cjbuckley4]

If a trader has grabbed queue position on multiple levels on the same side, the way I see it, they have two major immediate risks implicit in doing this no matter what your underlying strategy is:

Operational: some sort of issue arises, you can't cancel for whatever reason and prices move through multiple levels. All of a sudden, you're on the hook for a multiple of the size you normally trade.

Massive adverse selection: you have the risk that some really big trader has an informational asymmetry and takes out multiple levels simultaneously. Now you are on the hook for a multiple of your normal size and your counterparty knew something you didn't.

I'm looking for concrete strategies market makers use to mitigate these risks. One thought I had was perhaps to space out your attempts to grab Q by a few levels so that it takes maybe 1000 contracts to be executed before you can react instead of maybe 100 or something. There are downsides to this too. Maybe there's something implicit in mass quoting protocols or a specific type of order similar to OCO that could help that I'm not seeing in the CME documentation? Any information would be appreciated.

 

[Ghost_of_Blotto]

Operational: some sort of issue arises, you can't cancel for whatever reason.... Maybe there's something implicit in mass quoting protocols or a specific type of order similar to OCO that could help that I'm not seeing in the CME documentation? Any information would be appreciated.

http://www.cmegroup.com/confluence/display/EPICSANDBOX/Cancel+on+Disconnect

 

[Prorun]

IB has a feature called "One Cancel Another Group", that can be specified at order level. Check this.

Basically you assign a label to a set of trades, and when any of these is executed, the rest of trades are automatically cancelled. I use it and works very well.

It even can be adjusted to handle partial executions. If this happens in one of the trades, the rest of trades are reduced proportionally, so you never take a position larger than what you want.

Not sure about other brokers but maybe they have something similar.
Is this what you were looking for?

 

[cjbuckley4]

http://www.cmegroup.com/confluence/display/EPICSANDBOX/Cancel+on+Disconnect

See, this is starting to upset me a bit. I hate excuses, but I can't open like half of the CME documentation no matter what browser I try including this. I searched for exactly this as I knew it had to exist, but I couldn't find it. Now I know why. Thanks for pointing me I'm the right direction. I'll try to figure out what my issue is here.

That being said, there are other operational risks besides a disconnect. Risk of being too slow to cancel during major flow. Risk of a software problem that doesn't necessarily result in a disconnect. Etc.

@Prorun thanks, that's helpful. Do you know if this is supported by the CME exchanges or is it just something IB does on the client side? This is more of just an academic exercise. I'm interested in what the exchanges support locally vs. what brokers/FCMs provide.

 

[Gambit]

That being said, there are other operational risks besides a disconnect. Risk of being too slow to cancel during major flow. Risk of a software problem that doesn't necessarily result in a disconnect. Etc.

@Prorun thanks, that's helpful. Do you know if this is supported by the CME exchanges or is it just something IB does on the client side? This is more of just an academic exercise. I'm interested in what the exchanges support locally vs. what brokers/FCMs provide.

If a trader has grabbed queue position on multiple levels on the same side, the way I see it, they have two major immediate risks implicit in doing this no matter what your underlying strategy is:

Operational: some sort of issue arises, you can't cancel for whatever reason and prices move through multiple levels. All of a sudden, you're on the hook for a multiple of the size you normally trade.

Massive adverse selection: you have the risk that some really big trader has an informational asymmetry and takes out multiple levels simultaneously. Now you are on the hook for a multiple of your normal size and your counterparty knew something you didn't.

I'm looking for concrete strategies market makers use to mitigate these risks. One thought I had was perhaps to space out your attempts to grab Q by a few levels so that it takes maybe 1000 contracts to be executed before you can react instead of maybe 100 or something. There are downsides to this too. Maybe there's something implicit in mass quoting protocols or a specific type of order similar to OCO that could help that I'm not seeing in the CME documentation? Any information would be appreciated.

Buy or sell a back month if trading futures. Hedge with a basket of stocks or index. Cross the spread and get out. Double down and pray

 

[Ghost_of_Blotto]

documentation no matter what browser I try -
Are you getting those irritating "access denied" messages? Likely network based rather than a fault with your browser.

Still, the links browser might be worth a try. I much prefer browsing using it. Just the content, no rubbish...

 

[cjbuckley4]

documentation no matter what browser I try -
Are you getting those irritating "access denied" messages? Likely network based rather than a fault with your browser.

Still, the links browser might be worth a try. I much prefer browsing using it. Just the content, no rubbish...

Yup. The "access denied" error. Surprise surprise, it works this morning...

 

[Prorun]

@Prorun thanks, that's helpful. Do you know if this is supported by the CME exchanges or is it just something IB does on the client side? This is more of just an academic exercise. I'm interested in what the exchanges support locally vs. what brokers/FCMs provide.

As per my research, this is not CME native. It is handled by IB on the client side. IB's TWS needs to be up & running for this to work.

 

[cjbuckley4]

As per my research, this is not CME native. It is handled by IB on the client side. IB's TWS needs to be up & running for this to work.

Gotcha. As I'm really just preparing for the job market/screwing around looking at historical data, I'm really only concerned with that the exchanges offer natively vs what any broker or particular software vendor offers. Thanks for your reply though!

 

[garachen]

Most exchanges do cancel on disconnect. There's some safety functionality when using the mass quote message on futures options. Not intuitive how to configure but if you read the docs closely you can figure it out. I wish they had it for futures.
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