How do market makers make money?

Yup, theres definitely bad days, but its just about managing the variance in your P/L swings. If you make 5k a day 19 days of the month and lose 20k on the last day youre still up money. Whereas more long volatility type strategies lose 1k for 19 days of the month then make 30-40k on the last day. Still make similar money (assuming you know your edge) but exposing yourself to the occasional big hit not by default an unprofitable game.

 

Which instruments, if you don’t mind sharing?

 

All futures contracts. Equity indexes and energy mostly

 

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Partly true;
but they tend to be better than average traders/plenty of capital.
WHO says they are left with a huge inventory??Wrong.
[Also every day they can gap it up if they ran a bit short.]Some trade/invest their own accounts like we do.
.Public co for example VIRT/ 64% stock rise yield/better than average yield/eps.900%
Get real dude/as if all market makers/specialists never gap up or down open price////////////

 

in products like options - massive leverage with hedged positions.

 

The most profitable Market Makers seem to be in the OTC markets - and to do that, it takes really serious capital. Less crowded, more specialized, wider bid/ask spreads, and pure risk.

 

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And if we could mostly avoid a flash crash;
have to assume MM could avoid them even more.[I was in a dividend paying etf with about 1 million average volume.i thoght the flash crash IN THAT a bad quote/LOL still looks like a bad quote in hindsight.]NO way I would panic sell that nonsense.
I would have bought more if I could have gotten filled/not much volume on the flash crash.]AND Knight had a model/computer malfunction/max.............................................

 

Dr Jon Najarian describes in his book how market makers make money. To make the market he will take a long side on one trade being offered and then immediately has to seek placing an equivalent short trade in either stock or options to hedge off his risk and then keeping the difference of the bid and ask spread as his profit - he describes the mindset as walking out onto a street with bulldozers approaching both side to pick up nickels and dimes and then having to get out the way quickly before getting squashed.

 

Out of curiosity, how do you avoid getting filled other than quoting less if you need to sit x ticks away constantly?

And re: hedging it off, is it common for market makers to hedge off automatically into relative value trades or is it mostly pure arb and into the underlying?