The Lonely Art of Market Making: A Cautionary Tale in Liquidity (or Lack Thereof)

Ah, market making. The fine, misunderstood craft of standing between buyers and sellers, providing liquidity where it’s needed, and, if done correctly, making a living one eighth of a penny at a time. An eighth of a penny saved is an eighth of a penny earned.

In order to understand market making, we’ll approach this from the perspective of the market maker. So let’s pretend I am a market maker. What the hell do I even do? Well, my job is to constantly quote both a bid and an ask in whatever financial instrument some unfortunate soul has decided to trade. Ideally, I want to buy slightly below fair value and sell slightly above it, all while pretending I know what fair value actually is. Sometimes, in a liquid stock, this feels like a well-oiled machine, effortlessly capturing those eighths of a penny and making a steady income. Other times, it feels like I am a designated bag holder, especially when some institution decides to unload a position faster than I can type “WTF” into my risk monitor.

The Joys of Liquid Markets

For a market maker (me–still pretending, right?), making a market in liquid stocks is a dream—or at least a dream compared to the alternative. Take an S&P 500 stock with millions of shares traded daily. I can quote a bid and an ask with confidence, knowing that there are plenty of buyers and sellers on both sides. If I get hit on my bid, I can usually offload at the ask in milliseconds, collecting my crumbs and moving on.

But it’s not all sunshine and high-frequency trading algorithms. There’s tons of liquidity, sure, but there’s also competition—relentless, soul-crushing competition. Other market makers, proprietary traders, and hedge funds are all trying to do the same thing, only faster and with better technology. My bid? Front-run. My ask? Undercut. My self-esteem? Shot!

And let’s not forget the high-frequency trading (HFT) firms, those lovable ***holes of the financial world. They see my quotes, they sniff out my positions, and before I can say “market order,” they’ve flipped the spread, forcing me to chase prices like a kid trying to catch the ice cream truck.

The Horror of Illiquid Stocks

If liquid markets are an elegant ballet of efficiency and competition, illiquid markets are more like an awkward middle school dance where nobody knows what they’re doing. Imagine a stock that trades 3,000 shares a day, on a good day. I am the only one quoting a bid and ask, which is great—until someone actually takes my bid. Now I’m sitting on a position I can’t get out of, staring at a Level 2 screen with no one there. Anyone? Bueller?

Liquidity is an illusion in these stocks. That spread you see? Yeah, it might be $0.50 wide, but good luck trying to trade within it. I make a market because I have to, but God help me if a real order comes in. When it does, I become a glorified art collector—except instead of fine paintings, I own worthless pieces of paper that nobody wants.

The Sheer Terror of Options Market Making

If you think making markets in illiquid stocks is bad, try doing it in options. Options market making is what happens when you take an already difficult job and add the thrill of constant gamma exposure, volatility shocks, and theta decay.

Let’s say I’m quoting a market in AAPL weekly options, which, thank the good Gods above, is extremely liquid. Orders are coming in left and right, spreads are tight, and life is good—until some hedge fund unloads a massive position in a single trade, crushing my gamma and making my hedging look like a game of Whac-A-Mole. If AAPL makes a quick move, my risk models go from useful to utterly obsolete faster than a Compaq Presario in 1999 (look it up, kiddos).

Then there’s the real nightmare: illiquid options. Here, the bid-ask spread isn’t pennies—it’s dollars. The open interest is in the single digits, and the volume is abysmal. I quote a spread out of obligation, hoping nobody is crazy enough to take either side. And yet, inevitably, some retail trader with a Robinhood account decides that this particular out-of-the-money, six-month-expiry option is their golden ticket to riches. They hit my bid, and suddenly, I’m the proud owner of a position that I really don’t want in a market where I am the market.

The Psychological Toll of Being a Human Punching Bag

Let’s talk about the mental health of a market maker. When things are going well, I’m the picture of calm efficiency, flipping spreads, managing risk, and feeling like a trading savant. When things are going poorly, I question every life decision I’ve ever made.

I live in fear of market-moving news. An unexpected tweet, a rogue earnings report, or a misinterpreted Fed statement can turn my carefully hedged position into a slow-motion car crash. I am, in many all the ways, a glorified risk manager—only instead of managing risks, I mostly accumulate them and hope someone takes them off my hands before they explode.

The Inevitable Conclusion

So, should you aspire to be a market maker? If you enjoy constant stress, high-speed decision making, and the occasional existential crisis, then yes, it’s a great career! You will learn more about market structure, liquidity, and human psychology than you ever wanted to know, or even thought possible.

But be warned: you are not a trader in the traditional sense. You are a human liquidity provider, a servant to the gods of bid-ask spreads, an unwilling participant in a game where you must trade, whether you want to or not. The market does not care about your feelings. The algos certainly don’t. And your biggest hope is that at the end of the day, your P&L is green and your sanity is mostly intact.

If that sounds appealing, welcome aboard. If not, well, there’s always accounting.