What is a market maker?

[skinner36]

As all newbies I am doing lots of reading but I have come across a term that I don't understand.

Can someone please explaine what a Market Maker is?


Regards

John

 

[explod]

Re: What is a market Maker

As all newbies I am doing lots of reading but I have come across a term that I don't understand.

Can someone please explaine what a Market Maker is?


Regards

John

Sets prices under the auspices of the Stock Exchange. I understand they have a role in setting prices for the Warrant Market. Probably new floats. My knowledge it limited, surely others have more inner knowledge.

 

[cuttlefish]

Re: What is a market Maker

A market maker literally 'makes a market' for the instrument that is being traded (stock, derivative, commodity etc.). They do this by always being available as a buyer or a seller at the 'right price'. This ensures that if someone really wants to buy or sell the particular thing being traded there is always actually a buyer or seller there.

In practice what this means is that the market maker always ensure's that there is a spread on the instrument - i.e. they always have both a bid and an offer on a stock a distance away from 'fair value'. This means that anyone wanting to buy or sell does always have a buyer or seller there. It also means that anyone wanting to buy or sell has to compete with the market maker - thus ensuring that prices, if not ideal, are at least within a sensible range.

The stock exchange has official market makers in the options markets who have certain privileges and obligations. (e.g. they are obliged to create a market for certain categories of options and always provide a bid/offer spread on request if they don't have one in the market already).

 

[ShareIt]

Re: What is a market Maker

A market maker literally 'makes a market' for the instrument that is being traded (stock, derivative, commodity etc.). They do this by always being available as a buyer or a seller at the 'right price'. This ensures that if someone really wants to buy or sell the particular thing being traded there is always actually a buyer or seller there.

In practice what this means is that the market maker always ensure's that there is a spread on the instrument - i.e. they always have both a bid and an offer on a stock a distance away from 'fair value'. This means that anyone wanting to buy or sell does always have a buyer or seller there. It also means that anyone wanting to buy or sell has to compete with the market maker - thus ensuring that prices, if not ideal, are at least within a sensible range.

The stock exchange has official market makers in the options markets who have certain privileges and obligations. (e.g. they are obliged to create a market for certain categories of options and always provide a bid/offer spread on request if they don't have one in the market already).

thanks for this info... i was wondering if you could answer this... when you trade options, sometimes there are no market spreads available.... how do you go about getting a spread for a particular option when trading online???

 

[cuttlefish]

Hi ShareIt - I'm still learning the ropes of the options market myself so don't know all the ins and outs yet. If you call your brokers options desk you can get them to ask the market makers for a spread. In some options series they are obliged to provide you with a spread but in quite a lot they aren't obliged but they usually will provide one anyway. I've also found that if you place an order into the market a spread will generally pop up briefly at the time of putting the order on.

 

[GreatPig]

Re: What is a market Maker

They do this by always being available as a buyer or a seller at the 'right price'.

In the warrant market, the term "always" is used very loosely, as is the term "right price".

they always have both a bid and an offer on a stock a distance away from 'fair value'.

Again for warrants, their market making obligations only require they provide a bid, not an offer. However, if they never provided an offer, no one could ever buy their warrants.

GP

 

[sails]

Re: What is a market Maker

thanks for this info... i was wondering if you could answer this... when you trade options, sometimes there are no market spreads available.... how do you go about getting a spread for a particular option when trading online???

Agree with Cuttlefish that you need to phone your broker to ask for a quote. I believe they are only obligated to show it for about three seconds, so suggest you have pen and paper ready (or take a screen dump if trying to find a mid price for a combo spread).

I found it unacceptable to just put an order in first and then wait to see if they respond with a quote - you have already shown them your hand.

When getting the broker to request a quote only from the MM, they don't know if you are buying or selling. Usually they respond with a wide bid/ask spread, but at least you can see where the mid point is.

Of course, they will probably shift the quote once they see whether you are buying or selling - but at least one has some idea of fair price and can then decide whether or not proceed with the deal or not depending on the deal.

Sometimes wide option spreads can mean that that the bid/ask spread in the underlying share is also wide. If the MM needs to hedge his side of the deal with stock, then that also becomes an issue for him and not necessarily that he is being greedy.

It is near impossible to get filled at the mid price as the MM does have to feed his/her family and some of their money is made from the bid/ask spread.

 

[tayser]

At a high level - The Australian Securities Exchange is the biggest market maker of them all: they 'make' the Australian equities market by providing a platform to brokers to buy/sell the instruments.

"Market Maker Brokers" is what most people are talking about here - so when you trade in the markets that the brokers make, you're not trading directly with the higher level market which the brokers get direction from.

 

[Timmy]

Re: What is a market Maker

It is near impossible to get filled at the mid price as the MM does have to feed his/her family and some of their money is made from the bid/ask spread.

Glad someone has made that very fair point Sails. Have you seen the price of lobster, caviar and Moet now?

 

[Hyperion]

What is the benefit of being a designated market maker?

I understand they have obligations such as providing quotes a certain amount of time and limits on the spreads - but whats in it for them?

Hyperion

 

[doctorj]

I understand they have obligations such as providing quotes a certain amount of time and limits on the spreads - but whats in it for them?

The spread

 

[sails]

What is the benefit of being a designated market maker?

I understand they have obligations such as providing quotes a certain amount of time and limits on the spreads - but whats in it for them?

Hyperion

They pick up the amount between the bid and ask prices.

Say I want to buy a call option - and the price is bid at 15c and offered at 20c. For the sake of the example, lets say I end up paying 20c. Then a seller comes along and sells for 15c. The MM has made 5c.

Now, life is not that simple for the MM as he has no guarantee a seller will come along immediately to offset his risk and lock in his profit. So, depending on what else he has in his inventory at the time, he may decide to hedge his risk by using other options and stock.

In the example above where he sells me a call, he might buy stock and buy a put to remove his risk and lock in that 5c profit. 5c doesn't sound much, but if the order is for 10 contracts x 1,000 shares per contract - that is $500 for just one order.

 

[Hyperion]

But anyone can provide bid/ask spreads themselves.

Why would you bother becoming a registered market maker with the ASX so that you had all these obligations as well?

Hyperion

 

[Kauri]

a market maker... makes the market... invariably in your favour... so I am told...
Chears
..........Kauri

 

[sails]

But anyone can provide bid/ask spreads themselves.

Why would you bother becoming a registered market maker with the ASX so that you had all these obligations as well?

Hyperion

Firstly, I don't think retail traders are allowed to make a market. Secondly, the cost of hedging would probably make unrealistic for the retail trader.

 

[sails]

a market maker... makes the market... invariably in your favour... so I am told...
Chears
..........Kauri

lol - only if you can learn to ride their coat tails...

 

[cuttlefish]

But anyone can provide bid/ask spreads themselves.

Why would you bother becoming a registered market maker with the ASX so that you had all these obligations as well?

Hyperion

I'm curious to the answer as well - its true anybody can place a spread into the market so there must be more to the benefits than that.

 

[Trembling Hand]

In the case of options,
First call to any requested quotes.
Very low transaction cost.
Constant feed back from quote request
Constant feed back from seeing what retails traders are holding.
huge amount of transaction x small profit on each = BIG profit.
Option arbitrage (sell an option + hedging with stock) requires volume for $$ to get the volume you need the customers so you need to be registered

etc etc

 

[julius]

in order to 'make the market' you need to be able to constantly absorb the bid/ask - ie. deeep pockets. this is the main barrier.

otherwise you lose your ability to impose a profitable spread.