Life:
Good post.
Simple examples are the best, at least for me since I always follow the KIS principle. In simplest terms, the market maker runs the book on a stock, and nobody's book is as good as the MM's is. If he sees a lot of sellers at one price and a lot of buyers lining up at another price, he knows which way the stock is going to trend, and positions himself to bridge the gap and make a market so the stock can avoid stasis and trade. For example (simple example), if he sees 10,000 shares for sale in multiple offers at $50 and only 1,000 share purchase order at 49.25, and 9,000 at 48.75, he sees that the gap is too wide and so he'll offer to sell some shares (100 shares) at 49.75 and at the same time offer to buy shares at 49.35. He'll make a market in the stock and see which side comes in to take his bid/offer. If one of the $50 asks gets nervous and drops down to take his bid at 49.35, he now owns 100 shares at 49.35 and will adjust his own spread to maybe sell 100 at 49.65 and buy at 49.30, or better said: 49.30 X 49.65. Now one of the buyers comes in and picks up his 49.65 shares which leaves him with a 30 cent profit and the market is now 49.65, 49.50 X 49.60. At this point the market maker, having fulfilled his job description, may be able to step back out of one or both sides of the bid/ask and let the market function. If the gap begins to widen too much and the stocks don't trade, then he can, looking at his book, step in to either provide a bid or ask, whichever one indicates better the strength of the bids and asks which he can see.
In this example, the market maker went long first and then sold his position, but if the transactions had happened in reverse order he would have been short first (naked) and then long. So, of course market makers do their transactions "naked," that is, on the basis of their credit rather than actually putting up $$$$ or shares. No market maker could make a market in a stock if, before he bridged the gap by putting his own capital at risk he had to do a locate on shares to short. At the close of the day I assume they are almost always flat, since their goal is not to speculate on the direction of a stock one nano second longer than they have to.
Just my two cents,
Kb |
