Optimal market making in mutiple instruments

gaj · Post by **gaj** » Mon Jun 18, 2018 4:52 am

How do you skew your quotes when market making multiple instruments? Say you get filled in one instrument and you try to offload your risk in other instruments. So you skew your quotes in other instruments. But which ones and by how much? If you start skewing aggressively across all instruments, then you run the risk of getting filled in all of them. So you have to selectively choose which instruments to skew and not skew too aggressively. How do you guys do this in practice?

tabris · Post by **tabris** » Mon Jun 18, 2018 6:43 am

Too many variables and factors. You probably need to be more specific or if you are just asking in general then generally most folks actually skew it based on their probabilities of getting filled conditional on the instrument you just traded.

katastrofa · Post by **katastrofa** » Mon Jun 18, 2018 8:40 am

It's driven by risk management. If are long on financials and don't want to get longer, lower you bid quotes for companies in this sector.

ronin · Post by **ronin** » Mon Jun 18, 2018 3:03 pm

Any time you are quoting multiple instruments, you run the risk of getting filled on all of them. Skewing quotes doesn't change that.

In market making you typically work with some benchmarks. It might be time elapsed ("I want 100 shares in the next 6 minutes"), it might be quantity ("I want 1% of the next 10,000 shares"), it might be price ("I want 100 shares for less than 90.84"), it might be anything else.

If you fall behind your benchmark, you go more aggressive ("10% below benchmark, move 1 level in"). If you are ahead of the benchmark, you go more passive ("10% ahead of benchmark, move one level out").

And then make sure your benchmark for any specific symbol tracks your progression towards net and gross limits.

I am simplifying, but that is the basic idea.

gaj · Post by **gaj** » Mon Jun 18, 2018 4:32 pm

I'll be more specific. I was thinking of market making instruments where we have estimated "fair prices". Think of options for example. Say my bid is hit on 40D call. Then I try to hedge my vega by selling other strikes. I'm willing to lose x dollars to hedge this. So I lower my offers in 30D call and 25D call. But if I get filled in both, I'm going to lose 2*x dollars, and I'll have the opposite exposure.

As a manual trader, I would look for the instrument where it is cheapest to hedge, i.e., the one where my "fair ask" is closest to the market. Just focus the quote skewing on this one instrument. I think this is what tabris was saying as well. Is this what people do in practice? It seems a bit troublesome to automate. You have to keep track of which instrument is the cheapest to hedge in real-time and keep readjusting the skew every time it changes.

tabris · Post by **tabris** » Tue Jun 19, 2018 2:40 am

That's basically what I'd do. Automating the skew (or just cross the bid/ask to offload the risk like katastrofa) is not really an issue especially if you have the probabilities. Also not all instruments have a high correlation to the product you just traded. Some are stickier than others. The beauty of being a manual trader (I am guessing you are market making at a bank possibly OTC) is you also get the client ID vs probability of you making/losing money if you hedged aggressively or less aggresively. This should definitely help you, otherwise you might not get enough useful information on this and will have to extrapolate.

Jurassic · Post by **Jurassic** » Tue Jun 19, 2018 10:41 pm

> generally most folks actually skew it based on their probabilities of getting filled conditional on the instrument you just traded.

@tabris how do you get the probabilities?

tabris · Post by **tabris** » Wed Jun 20, 2018 1:38 am

if you are market making you would hopefully have had the data to estimate it quantitatively from your empiricals...

Strange · Post by **Strange** » Wed Jun 20, 2018 3:24 am

>> As a manual trader, I would look for the instrument where it is cheapest to hedge, i.e., the one where my "fair ask" is closest to the market. Just focus the quote skewing on this one instrument. I think this is what tabris was saying as well. Is this what people do in practice? It seems a bit troublesome to automate. You have to keep track of which instrument is the cheapest to hedge in real-time and keep readjusting the skew every time it changes.

I assume you trade FX vol and are one of the people that rapes me on a regular basis? ${L_SMILIES_SMILE}$ As a manual trader, you almost always end up considering pnl vs effort, e.g. "Strange lifted me in 100m of 1m 40 delta calls. I'll work equal vega in the 25 delta calls at fair offer for the next hour and will cross the spread if I can't get lifted". You got things to see and people to do.

As an automated OMM, you don't have to. You model/system can continuously adjust your skews and attenuate the book. E.g. you offer in both 25 and 30 delta but in modest size. As you are getting filled, (or not) you keep deciding if you still like this exposure, this level of aggression and the instruments you are skewing. Iin fact, IRL, you probably going to better offer smallish amounts across the whole surface (and possibly in related assets, if you are into that type of thing), with some parametric form for the skew vs your current exposures.

The only time you kinda have to do something aggressive is when you get negatively selected and are willing to pay up to get flat. As an automated OMM, most of your efforts are spent to avoid that type of situation.

Jurassic · Post by **Jurassic** » Wed Jun 20, 2018 10:02 am

@Strange I really cant see why there would be a substantial difference between a human market maker and a OMM in strategy. Why cant the human also skew various other instruments but in modest size?