CBOE's European exchange launch came with a flood of new data, giving us a chance to review a HUGE and under-followed part of exchange strategy. Class is in session! MARKET MAKER PROGRAMS 101:
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Most MM programs can be split into two halves: Obligations - what MMs must do when in the program Rewards - what MMs get for following program rules CBOE's program is no different.
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OBLIGATIONS MMs must quote prices in certain products at certain times of the day with enough size & quality to support liquid trading. CBOE lays out a scoring system to grade each of these parameters in a specific, detailed way:pic.twitter.com/KR080PtT2q
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REWARDS If MMs follow all program rules & get high performance scores they're eligible for sizable rewards. In CBOE's case, these rewards are: - Deep trading discounts - A monthly cash prize pool - Monthly revenue shares with CBOE itselfpic.twitter.com/KfC2DCLQ84
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From the exchange's perspective, these MM programs are a game theory exercise. We want MMs to do XYZ for the best markets possible; how do we do that? Giving firms ways to compete for large sums of $ normally gets the job done.
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From the MMs perspective, it's the same game theory challenge as the exchange, just flipped. Exchange incentives may cause them to trade a losing strategy just to get the rewards & come out profitable at the end of the month.
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If we see an exchange make quick changes to its MM program after a product launch, it could mean the program isn't working as intended, or they got feedback from the market & found a better strategy. Big changes in volume & revenue could follow.
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I find MM program strategy extremely fascinating, important and under-followed. If you found this interesting consider checking out my newsletter where I write about things like MM programs & other exchange topics:https://frontmonth.substack.com/
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