CUCaTS

A market maker quotes prices at which it will buy and sell. This supplies liquidity to participants who want to trade. See Optiver's overview.

Quotes and spread

Quotes reflect an estimate of value, the position already held, market conditions and costs. The bid–ask spread can contribute to revenue, but trades on both sides are not guaranteed and prices can move between them.

Inventory

Buying builds inventory; selling reduces it or creates a short position. The market maker bears price risk while holding that position and may adjust quotes or hedge to manage it.

Adverse selection

A quote can become stale when new information changes value. Trading against someone with newer or better information can leave the market maker with an immediate loss. This is adverse selection. See Optiver on quote cancellation.

Price, size and inventory

A quote includes size as well as price. A market maker can reduce quoted size when uncertainty or inventory exposure rises. A narrower spread can attract more flow while increasing the risk of trading at a stale price.

Inventory is a portfolio problem. Positions in related instruments can offset some risks while leaving basis, volatility or correlation risk. Count outstanding orders as potential inventory changes, not just already completed trades.

A simple inventory rule

In a simple quoting model, define a reference value, an inventory target and a maximum position. Shift the quote centre downward when inventory is above target and upward when it is below target. Keep the spread and allowed size as separate controls.

This rule defines a model; it does not establish that the model earns money. Evaluate fills, price moves after fills, hedge costs and inventory together.

Operational details

Track acknowledgement, fill and cancellation messages. An order awaiting cancellation may still execute. After a reconnect, reconcile positions and live orders before resuming quotes.

See Market Simulator for an original simulation design and Backtesting for evaluating a rule without future information.

Market Making