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delpacho


Total Posts: 1
Joined: Nov 2021
 
Posted: 2021-11-17 07:43
For those who have built or traded market making strategies, you know that cash assets are more complicated to deal with, as an initial inventory has to be maintained to be able to short the asset. The other option is to be able to be naked short, in that case the market maker does not need an initial inventory and can be short without cost (as long as it get flat at the end of the day).

For derivative, the market market can short the product without owning it (only margin requirements differ). In cash FX market maker easily get a loan at a low interest rate. However, I do not know how registered market makers (MM) in equity exchange get an initial inventory OR can short the stock without too much cost, (meaning borrowing it). Can someone know what is the general practice? If MMs get a loan, does the exchange or the issuers participate?

EspressoLover


Total Posts: 490
Joined: Jan 2015
 
Posted: 2021-11-19 17:28
In general there are three approaches depending on the country and the rules.

1) You get a borrow locate from your broker(s) at the beginning of the day. Make sure that the position never goes below that threshold. Equity market makers tend to trade with pretty small position limits, so this is rarely a binding constraint in major developed markets.

2) Naked short selling is allowed. Usually intraday. The market maker doesn't have to worry about borrow as long as his net position is flat by the close of the session.

3) You go out and buy all the shares in your portfolio up to your position limit. You then trade around this pretending it's the zero mark. Essentially all your sells are long sales, because you never dip into negative inventory. You then hedge either by shorting beta in an index future or something or by having a separate stagnant account with an equal amount of short shares. This is useful if there's an uptick rule.

Good questions outrank easy answers. -Paul Samuelson
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