Consider a market maker that has decided to try to make a round-trip trade in stock A in order to capture the bid-ask spread.
Assume furthermore that he has no current inventory in the stock A. To further simplify things assume that he wants to trade only one share in stock A.
The market maker now has to choose in which order he should submit the orders needed to complete this round-trip trade:
- Strategy I: Submit a buy limit order, wait for a match then submit the sell limit order and wait for a match
- Strategy II: Submit a sell limit order, wait for a match then submit the buy limit order and wait for a match
- Strategy III: Submit both the buy and the sell limit orders directly and wait for matches
Does strategy III strictly dominate strategies I and II? Under what circumstances would a rational market maker want to use strategy I or II rather than strategy III?