As we have discussed previously (earlier articles 1, 2, 3, 4, 5, 6, 7), the HedgeStreet® market greatly expands futures trading in two ways. First, HedgeStreet's futures and options instruments, called Hedgelets®, cover an unprecedented range of economic factors, from commodities to economic indices to currency exchange rates. Secondly, because HedgeStreet is an online exchange with low per-contract prices and modest fees, a broad class of investors previously priced out of futures trading can now take part.
One way to hedge or speculate on HedgeStreet is to buy Hedgelets that are offered on the exchange, then either sell them or hold them for settlement. Another way is to be a Market Maker on HedgeStreet. HedgeStreet's Market Maker Program gives qualified members the opportunity to participate in profit taking and to arbitrage new markets by offering to buy and sell Hedgelets in certain markets.
The role of the Market Maker on HedgeStreet is a simple one, both in concept and in practice. Market Makers maintain a two-sided displayed quote (i.e., buy and sell offers) for selected Hedgelets within a specified spread, adjusting the price and spread as they see fit based on changes in the underlying, market activity, and their own risk preferences.
Participants in HedgeStreet's Market Maker Program:
- Receive volume-based trading fee discounts and specialized service and support.
- Access special Market Maker tools, including the new HedgeStreet Trader tool and, where appropriate, a FIX order entry and trading systems.
- Earn royalties by suggesting and developing new instruments to be traded.
A Market Making Example
To take a closer look at market making, let's assume that the FX Group at Market Maker Group is making a market in a Weekly Binary EUR/USD Currency Hedgelet with a strike price of 1.1200 that expires at 5 p.m. ET on Friday, April 29th. If the underlying (the Euro/U.S. Dollar exchange rate) finishes above the strike price of 1.1200 on Friday, holders of this Hedgelet will receive $10; otherwise, they will receive $0.
Traders on HedgeStreet will price this Hedgelet based on their probability expectation of it's being in the money, adjusted for the risk on their overall book, on and off the exchange, and their risk preferences. As the underlying moves, they will trade these Hedgelets in much the way traders currently trade short-term currency options. Providing there is active two-sided response to Market Maker Group's posted prices, the Market Maker Group will also respond to the direction in which HedgeStreet's retail membership moves the market, as long as Market Maker Group can do so profitably and without the accumulation of a position unreflective of its own probability expectations.
Now let's assume that Market Maker Group receives a pricing feed tick for the underlying (EUR/USD) at 1.1290. This tick is input to the Market Maker Group option-pricing model, which combines it with other parameters (such as strike price, volatility, time to expiration, and skew) and then calculates an option price. The pricing model can also have risk preferences built into it to automatically widen (or narrow) the quote spread based on Market Maker Group's exposure preferences.
Once Market Maker Group has generated the option/future prices and spread, the prices are then sent from Market Maker Group to HedgeStreet via HedgeStreet Trader or the separate FIX gateway. HedgeStreet immediately adjusts the Order Book to reflect the received pricing.
When retail traders hit Market Maker Group's offer prices, HedgeStreet executes the trades. Confirmation of the trades is sent to Market Maker Group via the FIX gateway, as well as via email, and Market Maker Group inputs the trade information to its pricing model, which adjusts volume and skew accordingly.
This process repeats with each new tick of the underlying, until the Hedgelet expires and Market Maker Group's Hedgelets are settled based on the final status of the underlying.
Becoming a HedgeStreet Market Maker
Any active HedgeStreet member can apply to become a Market Maker. For more information about the Market Maker Program, contact instruments@hedgestreet.com or go to www.hedgestreet.com/abouthedgestreet/marketmaker.html.
Visit HedgeStreet.
