Making Markets
When two people disagree about the value of something, they might want to trade with one another. We'll say that
two people trade a contract. Here are some examples of contracts:
1) In what year was Mark Twain born?
2) Will the Yankees win the next World Series?
Each contract is a question. When we learn the answer, we can give the contract a final value, called the settlement
price. The first contract above will settle to the year Mark Twain was born, or 1835. The second will settle to either 0
(if the Yankees lose) or 1 (if they win). Note that the settlement price of the first contract is predetermined, whereas
the settlement price of the second is not.
In the course of trading, you need a way to say what trades you’d be willing to do. For example, suppose we’re trading
a stock, and you’d be happy to buy 100 shares for $34. You would say,
“34 bid for 100.”
How does this encode your message? First, the word bid always indicates that you’re on the buy side. The word for
means the same thing; it’s only used in expressing a desire to buy. Second, you are giving a price at which you’re
willing to buy (34) and a size indicating how many contracts you’d be willing to do (100). Finally, in showing a bid,
you always say the price first and the size second.
If you were instead looking to sell 100 shares at $36.8, you would say “100 offered at 36.8.” The key differences? The
words offered and at are both used only in offers to sell, and the size now comes before the price.
Here’s a quick check. If an experienced trader says “17 for 25” in trading some contract, are they trying to buy or sell?
At what price and for how many contracts? What if they say “30 at 9”?
A proper market quotes both a bid (buy side) and an offer or ask (sell side), using the jargon above. So your
market in the stock might be
“34 bid for 100, 100 offered at 36.8.”
Let’s make a market on the flip of a coin. Contracts will settle to 100 if the flip is heads and 0 if the flip is tails. What’s
your market? Since you know the fair value is 50, you might say “45 bid for 10, 10 at 55.” If I sell you ten contracts at
your bid of 45, you’ll make $50 in expected value. (Why?)
If you’re more confident in your fair value, you could show a tighter market, such as “49 bid for 10, 10 at 51.” If you’re
uncertain — or just don’t like the risk — you might state a wider market (“40 bid for 10, 10 at 60”) or reduce your size
“45 bid for 3, 3 at 55”). If you’re willing to trade more on one side of the market (perhaps to manage your risk) you
might show more size on the bid or offer, as in “45 bid for 5, 30 at 55.”
If your bid size and ask size are the same, you can save time by saying “bid price at ask price, size up.” Expressed
this way, our market in the stock would be “34 at 36.8, 100 up” and our market in the coin would be “45 at 55, 10 up.”
If you decide you don’t like your quoted market, you can clear your market by saying “I’m out” before a trade occurs.
(For example, perhaps you make a market of “34 at 36.8, 100 up” in the stock, then shortly afterwards see a news
report announcing that the stock has sold many more widgets this month than they did last month.)
Until you clear your market, it’s presumed to be available for others to trade on — no takebacks!
Sometimes you might be interested in trading on other people’s markets. To buy all the contracts on the offer, say
“buy ‘em!” or “take ‘em!”. To sell all the contracts on the bid, say “sold!”. To trade some but not all, specify a size,
as in “buy 5!” or “sell 10!”.
Please practice making markets — out loud! — before your interview. Here are a few to try, but you should also make
up some of your own.

The population of New York City

Germany winning the next World Cup

The number of stocks in the FTSE 100