I can't see how it'd be done in a 1-penny spread stock. Anyone out there in this business? How do these guys make money anymore? The other question is -- without order-flow analysis, how do people quantitatively come up with prices for what the stock should actually be? I see how it works with options, but what about stocks?
First...yes market makers make money. Think about it, they are dealing with millions of shares that are trading. Those "penny" spreads add up pretty quickly. Second, no...there is no sure fire way to quantitively price stocks. The price is the price. With an understanding of how to read financial statements, you can get an idea of which direction the price will go in, but at the end of the day, it's the "market" that determines the price of a stock.
Lets do the calculations: 1,000,000 shares a day * .01 = $10,000 a day $10,000 a day * 250 trading days = $2,500,000 I would call that a nice year.
So if there's no sure fire way, how are MMs adjusting how they offer liquidity? There's no way they can properly be on the bid AND ask to get the 1 penny perfectly. I can see them sitting around at 5-10 cent levels and taking liquidity when they want, but at 1 cent?
They use computer algorithims to adjust the bid/ask. They follow market movement and trade against humans. Rarely do they actually manually post bids/asks unless its a low volume, high b/a spread stock. Even options aren't manually made into a market (except SPX), I was down at the CBOE last December and they were just sitting back in their chairs watching the computers do the work and once in awhile hedging positions or accomodating large block trades from other floor members.
There are a lot fewer of them making money these days. Look how beat up the specialists on the NYSE have gotten in the last 7 years. Dont forget there are all kinds of payment for order flow deals, rebate deals and soft money deals in market making.
Agreed robbie, there are a couple of things missing like fixed expenses, variable expenses etc etc etc etc etc