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I am trying to understand some MM (Market Maker) data that I have.

As a follow up to a question I read about MM:

How does a dealer (or market maker) earn the bid-ask spread on a stock?

And to this piece of information from Investopedia:

Market makers must maintain continuous two-sided quotes (bid and ask) within a predefined spread.

I am wondering the following:

Is a MM obliged to quote a bid and an ask price at the same time?

E.g. take a look at the following raw piece of MM data:

MMExchange, MMID, MMBid.Price, MMBid.Size, MMAsk.Price, MMAsk.Size
Q,          NSDQ, 2.25         6,          2.29,        19

Interpreting this data, I get the following:

MM Exchange : Q
MID         : NSDQ
MM Bid Price: 2.25
MM Bid Size : 6
MM Ask Price: 2.29
MM Ask Size : 19

Note:

  • Price is in dollars: so the displayed spread is 2.29 - 2.25 = $ 0.04
  • Size means the number of shares that the MM is quoting for the given bid and ask (I believe it's quoted in thousands)
  • I got the data from a reliable source (so I'm sure it's correct)
  • I'm referring to Registered Market Makers here (so not private investors)

Now I have the following questions:

  1. Did the MM quote these bid and ask prices at the same time?
  2. Why is the MM (price) spread larger than the current bid and ask spread? (I also have that data: the price quote that exchanges send out)
  3. Does this mean that I can calculate the profit the MM is trying to make on this quote?
  • Some of your question is not clear. For instance how are you seeing a larger spread? Is that the "Size" values (i would interpret that as the number of shares in the last sale)? Are those units in cents? That seems like a really big spread. Also where are you getting this info from? – mlathe Apr 7 '14 at 20:37
  • @mlathe: Your questions are rather trivial: size = number of shares. Quoting a price has nothing to do with a last trade. Units are dollars. Large spread because it is a small cap stock. I got the info from a data provider. See updated question for some extra info I added for you. – Jean-Paul Apr 7 '14 at 22:02
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    Note that anyone -- even an individual investor trying to buy or sell 1 share of stock -- is technically a market maker when they send a limit order to an exchange. So there are millions of transient market makers for every symbol on every exchange every day, and there is certainly no rule that states they have to enter both sides of the book. I think you may be referring to Registered Market Makers, who do have to follow certain exchange and governmental rules about providing liquidity. – dg99 Apr 10 '14 at 17:22
  • @dg99: Yes I'm aware of it. I didn't realise that people would use the MM for unregistered marketmakers as well. I'll redefine it. Please feel free to submit an answer about those exchange and governmental rules below. – Jean-Paul Apr 10 '14 at 17:35
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    You did not click enough times. The Lead Market Making brochure is the first link on the ARCA page, for example, and discusses the two-sided quoting rule. – dg99 Apr 11 '14 at 21:40
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+50

Market makers (shortened MM) in an exchange are generally required to list both a bid and ask price to allow both buyers and sellers to trade and keep the market moving. However, a more general idea of a MM may includes companies off an exchange (say large banks acting as broker/dealers in an over-the-counter market) are not required to give a simultaneous bid/ask, but often will on request. So, it might depend on where you are getting this data but likely the bid/ask was quoted simultaneously.

An exchange, like the NASDAQ for instance, may have multiple MMs for a given market. The "market" spread will be from the highest bid to the lowest ask over all the MMs. The highest bid and lowest ask may come from different MMs and any particular MM often will have a larger spread.

The size of the spread gives a rough idea of how much a MM is trying to make off of a "round trip" trade (buying than immediately selling to someone else or selling than immediately buying from someone else). Of course, immediate round-trip trades are not always possible and there are many other complications. However, half the spread is a rough indicator of how much they hope to make off of a single trade.

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  1. Yes, but also note each exchange have rules that states various conditions when the market maker can enlarge the bid-ask (e.g. for situations such as freely falling markets, etc.) and when the market makers need to give a normal bid-ask. In normal markets, the bid-asks are usually within exchange dictated bounds.

  2. MM's price spread can be larger than bid-ask spread only when there are multiple market makers and different market makers are providing different bid-asks. As long as the MM under question gives bid and ask within exchange's rules, it can be fine. These are usually rare situations. One advice: please carefully check the time-stamps. I have seen many occasions when tick data time-stamps between different vendors are mismatched in databases whereas in real life it isn't.

  3. MM's profits not just from spreads, but also from short term mean-reversion (fading). If a large order comes in suddenly, the MM increases the prices in one direction, takes the opposite side, and once the order is done, the prices comes down and the MM off-loads his imbalance at lower prices, etc.

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