Entry Roles
Breaking into institutional market making requires a strong foundation in mathematics and statistical concepts. Most firms prefer candidates with STEM backgrounds. Quantitative researcher and developer roles tend to have higher barriers to entry than quantitative traders, often requiring some level of higher education. This allows quantitative researchers and developers to command greater salaries at the beginning of their careers. However, due to trading’s performance-based nature, traders will generally take home significantly higher bonuses as they progress past their training stages and advance in proficiency. These roles aren’t exactly cut and dry though, as quant traders do play a heavy hand in algo-development and parameter optimization.
Market making is a fundamental activity in financial markets where participants provide bid and ask prices, along with size, for assets. Market makers are compensated for the risks they assume (Greek, inventory, gap, etc.). They also receive compensation for the immediacy and liquidity they bring to the market.
Contrary to a common misconception, market makers do not simply profit by buying at the bid and selling at the ask.
As an illustration, here's an example of an eight-wide, two-sided market on the expected temperature for the next day, with a $20 bet size:
One may notice in this diagram that there is no directionality in play.
Market makers do not express opinions on whether the price of a security will rise or fall; they serve as risk conduits that provide liquidity for market participants.
As such, recognizing and removing bias is one of the most key elements of the business.
Firms profit from the edge collected from the difference between the theoretical value and price bought or sold adding as market takers buy at their offer and sell to their bid consecutively day in and day out; as long as buyers and sellers exist, MMs can collect edge.
For example, if the temperature is 61° F, then everyone who projected 79° F is wrong and vice versa.
Volatility
High volatility and increased risk can lead to market makers widening their spreads to compensate. When this wider spread is interacted with, market makers can achieve higher profits.
Temperature, in this scenario, is an analogy for volatility, as puts and calls serve as projections on price movements.
MMs profit when volatility is high, as this allows for larger edge and the value of calls and puts increase due to the expanded ITM probability range. Furthermore, times of increased volatility allow for MMs to realize position outcomes at a faster rate, rather than slower times when inventory risk is high. However, competition among MMs, as well as the rise of computerization and high-frequency trading (HFT), has kept spreads tight and markets liquid.
Institutional market makers, often associated with proprietary trading firms, play a vital role in financial markets by providing liquidity and contributing to price discovery. Providing liquidity is essentially ensuring the smooth flow of transactions by being willing to take the opposite side of a trade, even when there isn't an immediate counterparty.
Institutional market makers are committed to buying or selling derivatives consistently at specified prices. Alongside providing liquidity, they also reduce price volatility and facilitate the process of price discovery by establishing a trading range for a particular security. They calculate a theoretical value for options and then quote a bid (buy) price below that value and an ask (sell) price above it, with specified sizes for each. Their profit comes from the spread, which is the difference between the bid and ask prices.
Essentially, traders use the tools the developers and researchers make while focusing on managing portfolio risks and seizing unique market opportunities not captured by existing models, especially during rare events or high volatility. A trader at a firm I interned at described it like so:
“Imagine being a trader as being the captain of a huge fishing boat. You have a net capturing small sardines behind you - those are the orders being filled by the algorithms… However, you’re at the front of the ship manning a harpoon, always looking for the next big whale.”
The recruiting process at these firms can be found here. One special thing to note is that for this particular industry, teaching assistant roles for math and CS classes are quite competitive for past experience.
Some proprietary trading firms operate as “arcades" that function as pay-to-play environments with exploitative practices. It's important to exercise caution and thoroughly research firms before considering employment with them (they’re not considered market makers, but rather market takers). This is the same case for the proprietary firms with “funded accounts”. Avoid these like Chernobyl.
https://www.youtube.com/watch?v=B8Hx9ZsL1bE
You’re going to hear “edge” a lot on this page. The basic gist of market making as a business is the collection of edge and the management of the risks that have accumulated from that collection.