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gagyang


Total Posts: 5
Joined: Jun 2020
 
Posted: 2021-06-13 07:24
I have been looking at this instrument with the following characteristics:
It’s a thick tick instrument that tracks a much thinner tick instrument almost perfectly linearly, so micro price is easily derivable. Price discovery is almost completely done in the thin thick instrument (much bigger volumes in thin tick instrument). Queue priority at market open isnt FIFO but lets assume its randomly distributed per lot.

With all this, seems to me the market players will then only be competing on cost of capital? The more access to capital the player has - the more orders they can place and higher chance of getting filled? And in a theoretical world people will just be layering as many orders as possible until margin benefit of each additional order equals cost of capital?

Its Grisha


Total Posts: 92
Joined: Nov 2019
 
Posted: 2021-06-13 19:07
I think in addition to cost of capital you still need to consider the adverse selection. A player with unlimited access to capital is not going to asymptomatically make up 100% of the touch because if a very directionally informed trader steps in at open, they can take all of that liquidity and your mark to market pnl would immediately hit -$big number.

In other words, right now price discovery happens in the thin tick instrument, but if the resting size in the thick tick starts to exceed it, the “price discoverers” will start taking liquidity from the deeper book to the extent that it's cheaper to execute there.

Depending on the exact mechanics there might be competition on latency too. Even without vanilla time priority at each level, there can still be a race to cancel or add size to the random selection pool at that level.

I have not actually traded a market with this mechanic, so these are mostly just intuitions. Maybe someone with the experience can elaborate further, but I'm pretty sure cost of capital is an oversimplification here.

"Nothing is more dangerous to the adventurous spirit within a man than a secure future."

gagyang


Total Posts: 5
Joined: Jun 2020
 
Posted: 2021-06-26 07:58
I didn't consider the point on how price discovery could shift to the deeper books as liquidity adds up, especially at points when thin tick instrument is not that far off from the tick flip points. Thanks for your insight!
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