# Tag Info

11

All HFTs are event driven. In the most basic sense, they have some model that is a function of order book events. For every order book event the model calculates some micro price that is the HFTs perceived fair value. This is often a function of the current bid, ask, depth, last n trade prices, inventory, etc. Given the most up to date view of fair value, ...

10

The best explanation/theory that I have heard about Knight's erratic trading was put forth by Nanex. I have pasted their summary of findings below. We believe Knight accidentally released the test software they used to verify that their new market making software functioned properly, into NYSE's live system. In the safety of Knight's test ...

10

An interesting starting point is The Cost of Latency by Moallemi and Saglam. After setting up a simple order execution problem --- in which a trader must chose between a market order and a limit order and guarantee execution over a fixed interval $[0,T]$, they proceed to derive a (complex) close form solution for the optimal strategy and evaluate the impact ...

7

The way market makers mark their volatility curves is by using models which 'fill in the gaps', i.e. they will make a price for a given option even if they do not believe this option is going to get a lot of volume. They are still willing to go long/short because they have a strategy to hedge their overall position (i.e. by managing their greeks and ...

7

A good place to start learning about option market making using quantitative techniques is Euan Sinclair's Option Trading (chapter 10 is devoted to market making techniques). He also gives a decent introduction to a more sophisticated quantitative market making technique which he calls information-based market making. Specifically, he explains how to apply ...

6

My favorite culprit is quote stuffing, which can be used for a lot of things, including mapping the topology of the exchange servers themselves. The general idea is to look for bottlenecks which can then be lagged with more targeted quote-stuffing to create arb opportunities. Nanex's flash crash analysis covers this to some extent: ...

6

Market makers covers a broad range of shops, from large investment banks to small proprietary trading firms. So working capital can be in the millions or the billions, and leverage can be anywhere from 2x to 30x. This is no different from buy-side firms, which includes a variety of both asset managers and retail investors. There is tons of diversity among ...

6

Are you after the famous paper from Christie and Schultz? Christie,W., Schultz,P., 1994. Why do NASDAQ market makers avoid odd-eighth quotes? Journal of Finance 49,1813–18 40. From the abstract: On May 26 and 27, 1994 several national newspapers reported the findings of Christie and Schultz (1994) who cannot reject the hypothesis that market makers ...

5

This paper Dealing with the Inventory Risk. A solution to the market making problem, has a full bibliography and explains the intra day market making mechanism. The model is made of two components: a diffusion of the fair price (to model the market risk) a point process (with an intensity in $A \exp -k \delta$ (where $\delta$ is the distance to the fair ...

5

Market makers place quotes on both sides (ie, the bid and the ask). Depending on the market, the MM might even be contractually obligated to provide liquidity within some threshold. NYSE's designated market makers (who replaced the specialists a few years back) are an example. Even when there is no explicit requirement, the MM will quote both sides and ...

5

All things being equal, stocks with the highest bid-ask spread present the greatest opportunity for the market maker The size of the opportunity (i.e. revenue expectation) can be represented as Volume * Bid-Ask Spread. Your algorithm should rank-order that revenue expectation Stocks with high current market values will tend to have narrower spreads and be ...

5

I don't know if you can really improve, the point of Market Making is that you don't know when you'll be executed. It also depends a lot on the type of product you're trading, it's not the same business Market Making far from the money options (where you will never be executed but just offer a reference price and answer traders phone calls) and MM on ...

4

Your friend might be right, if, for example, he was talking about making a market in a set of low liquidity stocks. But that usually requires a market-making model where you're inventorying shares, for longer periods of time, which adds risk. Returns can be 'good' though. There are other scenarios, that are exchange-model dependent, that would also ...

4

The problem with this question is that the real world answer is probably different than any theoretical answer. Below is my stab at some "real world" nonsense. 1) Assuming that both Foo and Bar have the same market capitalization and no debt, their market caps would be co-integrated (over time, they wouldn't stray too far from each other). 2) Because of ...

4

The paper "High Frequency Trading and The New-Market Makers" by Menkveld will likely have information that will be interesting to you. The paper breaks down the activity of one HFT in a European market. It provides statistics such as the # of trades, capital required, average profit, loss, etc. You can judge for yourself whether you trust the numbers based ...

3

Update via Bloomberg Knight Capital Group Inc. (KCG)’s \$440 million trading loss stemmed from an old set of computer software that was inadvertently reactivated when a new program was installed, according to two people briefed on the matter. Once triggered on Aug. 1, the dormant system started multiplying stock trades by one thousand, according to the ...

3

There are two excellent choices for implementing prediction markets: (1) Use book orders that stand until filled, just as intrade.com does. (2) Use an automated market maker (like Robin Hanson's) that stands ready to make trades. The book orders model is very simple to implement, but can suffer from very wide Bid/Ask spreads. And, it can be tough to bet ...

3

Assuming that: limit prices of Long and Short orders are equally pre-calculated in all 3 strategies; there is no risk-free return; strategies 1 and 2 have equal quality, and strategy 3 is slightly better. However, the only advantage that strategy 3 takes over 1,and 2, is better location of the orders in the price level queue. In case of FIFO (price-time ...

3

It sounds like you're trying to filter your input event stream so as to reduce noise. By reducing noise you'll reduce the number of cancel/replace's you're doing and, hopefully, have a better order-to-fill ratio. I would investigate algorithms from control theory, in particular dynamic linear models like Kalman. The problem with denoising is you want to ...

2

These Alpha Indexes are a bet on the excess returns of the target instrument. Options are, ultimately, a bet on the volatility of the underlying. The two are not related. If you wanted to replicate an Alpha Index of gold against copper, just buy gold and short copper (usually through the futures market). Again, this has nothing to do with options.

2

This question is for a part answered by a recently published article: High-Frequency Technical Trading: The Importance of Speed This paper investigates the importance of speed for technical trading rule performance for three highly liquid ETFs listed on NASDAQ over the period January 6, 2009 up to September 30, 2009. In addition we examine the ...

2

"does the underlying usually see increased trading?" Not necessarily. Most market makers do not re-hedge much in the underlying. In many markets the delta is exchanged (off-exchange) alongside the options trade at initiation, making both parties delta neutral at the outset. Re-hedges in large vol books are generally accomplished through other options and ...

1

You first need to clearly define your constraints first: max single position size max net exposure I am not sure why you want to limit order size. The whole idea of hft strategies is to maximize turnover. As long as your strategy generates alpha you should allow it to trade as often as the strategy prescribes. All you need to then do is to constrain the ...

1

The best options AMM guys are rumored to capture roughly 1/3tick per round trip, net of transaction costs + implementation shortfalls. I had worked for a regional index options MM. With the growth of competition in the recent years, expected returns are actually much lower than that today. So realistically, in today's environment, you could net maybe ...

1

The mistaken belief you refer to is a common confusion between stating that the price went up because demand went up and/or supply went down (tautologically true, but meaningless statement) or because buyers entered the market and/or sellers exited the market (usually false). This has nothing to do with options or implied volatility. I see such confused ...

1

My understanding is that this is a completely new product which is not perfectly statically replicable given current instruments. The product, which your explanation does not make clear, is an option on an index, where the index value is close to (but not exactly, due to dividends) the total return from a long-short position in the two underlyings. It is ...

1

Actually depends on the kind of market you are trying to make, if you are a authorized MM some markets/exchanges have special structure for market makers so they don't really pay for every quote that they send to the system, instead they pay a fixed amount of fee to have certain rights and responsibilities for a particular bin(set of instruments) of the ...

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