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Making a Market in a Binary

Market making a binary is the purest version of the "make me a market" game every trading interview plays: pick a fair value, wrap a spread around it, and adjust as trades and information arrive. What is different here is what is missing: there is usually no instrument to hedge with, so every fill is risk you keep until resolution.

Centre and width

A quote has two decisions in it. The centre is your fair value pp, built from base rates, models and whatever the market itself is telling you. The width prices what being wrong costs: quoting p±wp \pm w, you earn the spread 2w2w from uninformed flow and lose to anyone who knows better than your centre. The tighter you quote, the more you trade and the more each mistake costs; the wider you quote, the safer and the more irrelevant you become. Width should grow with your uncertainty about pp, with the variance p(1−p)p(1-p) of the inventory you would take on, and with the toxicity of the flow, the next lesson's subject.

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