Market Maker

What the job actually is

A market maker quotes a two-sided price and stands behind it. That is the whole product: whoever needs to trade right now can, because somebody is willing to take the other side. The revenue is the spread between the two prices, earned a fraction of a cent at a time across enormous volume.

The work is not forecasting direction — a market maker who has a view is usually doing the job badly. It is pricing two risks continuously. The first is adverse selection: the counterparty chose to trade with you, which means your price suited them, which means it was probably wrong. The second is inventory: order flow does not arrive in matched pairs, so you keep ending up holding positions you never wanted and are not paid to hold.

Those two risks call for opposite tools, and the entire skill is telling them apart in real time. Information risk is priced with width — charge everyone more, because you cannot tell which fill is the informed one. Position risk is priced with skew — move the whole quote so the flow flattens you for free. Confuse the two and you either bleed to informed traders or accumulate a position you cannot get out of.

The calls that define it

• How wide to quote — the premium on a free option you are writing to the entire market
• Where to stand in the queue, and whether a tick is worth paying to skip it
• Whether one-way flow is somebody working size or somebody who knows something
• When the flow has turned toxic and the only winning move is to stop quoting

Sits at a market-making firm, a bank's flow desk or a proprietary trading firm; measured on realised spread rather than quoted spread, and constrained by an inventory limit that is enforced automatically and is not a suggestion.

What you'd need to know

The concepts this chair runs on — each one links to a plain-English definition.

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