A hands-on options curriculum covering real trading concepts. Read the lessons, work through examples, and test your knowledge.
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Key terms in this lesson
Lesson 6: 3.5: Market Making Mechanics and Inventory Risk
Explore the bid-ask capture strategies, market maker inventory models, and the cost of holding inventory.
1. Inventory Control and Quote Adjustment
Market makers operate by posting simultaneous buy and sell limit quotes, aiming to capture the spread. However, if they get hit repeatedly on one side, they accumulate an undesired long or short position (inventory risk).
According to classical inventory models, a market maker holding too many shares will shift both bid and ask quotes downward (shading) to discourage further buy fills and encourage sell fills.
★ Formula Principle: Bid/Ask pricing = Fair Value +/- Inventory Penalty.
Click to enlargeOptions Structure Exploration
Options are contracts cleared in the bid-ask auction market. Interact with the Order Book below to understand how buy offers (bids) and sell offers (asks) intersect, and inspect the structural breakdown between Call and Put contracts.
Limit Order Book & Spread Interface
Hover over ASK or BID to dissect the auction market dynamics.
Right to Buy
- Outlook: Bullish (Goes up)
- Risk: Capped to premium paid
- Profit: Scales as stock surges
Right to Sell
- Outlook: Bearish (Goes down)
- Risk: Capped to premium paid
- Profit: Scales as stock falls
KNOWLEDGE RECONNAISSANCE
How does a market maker adjust quotes when holding excessive long inventory?
More lessons in this module
- 3.0: Limit Order Books and Bid-Ask Spreads
- 3.1: Understanding Market Depth & Level II Data
- 3.2: Market Impact and Slippage Mechanics
- 3.3: Order Flow Imbalance (OFI) & Price Discovery
- 3.4: Adverse Selection & Toxic Order Flow (VPIN)
- 3.6: Dark Pools and Block Trading Execution
- 3.7: High-Frequency Trading (HFT) and Microstructure
- 3.8: Limit Order Book Modeling & Queue Position
Signal Desk is where you practice this on real stocks: real option chains (about 15 minutes delayed), the Trade Check and a paper-trading account that risks no real money. Join to add it, your progress tracking and PDF downloads.