Alligator Spread

Finance allah shmoop What is a market maker What is

a market maker Hint He comes right after the butcher

and the baker Okay so you have lots of buyers

and lots of sellers and they come together a g

rated lee in a market which is so big it

has to be divided into segments or sections or sub

groupings of aa few stocks or bonds in which the

specialist trades and that specialist volunteers there time because they

loved it well actually know that not all true they

get paid a lot Ah lot When things go well

how are they paid Well through spread and not the

warm butter kind Instead spread refers to the money value

between a bid and an ask price under a market

maker structure of trading securities No more wire hangers a

plastic hanger company is publicly traded on an exchange like

nasdaq where buyers bid for a price to purchase and

sellers asked for a price to trade no more Wire

hangers is bid this moment at thirty seven twenty three

a share by buyers willing to pay by right now

at that price and is being asked at this moment

at a price of thirty seven thirty one Note the

eight cents a share difference in the share prices that

def is the spread between the two prices and it's

worth noting that in extremely volatile stocks the spread widens

and in boring highly liquid stocks which don't move much

the spread titans or is narrower that is on a

volatile equivalent of no more wire hangers The spread might

grow to twenty or thirty cents a share whereas a

boring name that pays a big dividend and the stock

never moves much We're thinking t here well that spread

might be just three or four cents So why grow

Well Because a market maker in a volatile stock doesn't

want to be caught losing money on her inventory The

market maker never once to be punished for providing liquidity

and market makers provide liquidity for stocks bonds and well

basically anything else they think they can generate revenue from

spreads in If no more wire hangers suddenly gap down

to thirty seven Ten a share Well it would be

likely less than the average of what the market maker

pa paid for her quote inventory unquote in that stock

from which he was making a market in it Each

time the shares trade the market makers dip into that

spread to pay their bills and allow them to keep

doing business So that spread and it's not the type

that prince used teo sing about Okay so then specifically

what's a specialist i wouldn't have a movie Stallone wait

different kind of specialist in finance land a specialist is

the gala guy trading in a given stock that is

there a member of a stock exchange and they might

carry inventory of satan Ten million shares of microsoft trading

currently at around forty bucks a share Their offering msft

for sale it forty point oh five and they're our

buyer of msft this moment at thirty nine ninety one

and see there's a fourteen cents a share spread their

meaning that they make fourteen cents every time they transact

So let's say that specialist sells a million shares of

microsoft today earning a fourteen cents spread per share while

fourteen cents times a million one hundred forty grand and

clown Nice a day for one day's work so that's

a pretty widespread in the scheme of things because often

brokers have to tack on their own commission of a

few cents on either side and the specialist might in

fact be dealing from their inventory to brokers on both

sides of a transaction in which case they're spread I

even spread to the actual specialist might be just a

few cents times those million shares like four cents times

a million gets forty grand something like that It's still

a really good living But if it's so good then

why don't millions of people fight for that job Like

how hard it is Is it tio Just nod your

head and right down buy or sell and then a

number You think everyone who flips burgers at mcdonald's and

is afraid of robots taking their jobs would be killing

for this gig Well in order to be a specialist

Not only do you need you know special education and

a few siri's license exams but you also need capital

with which to buy inventory risky inventory which you'll hold

as if they are casino chips and you are more

or less the house So when the microsoft shares example

just to be a specialist in that one stock well

you have to raise something like one hundred million dollars

because you'll have to go into the market to start

and simply by you two or three and call two

and a half million shares at around forty bucks each

for a total cost of ahhh ondo or a silicon

valley unit That's What units called out here And yes

that's an investment in the stock could go up but

it could go down as well leaving you holding a

big fat smoldering bag of dog crap dot on and

also going whoever your investors or creditors workout one hundred

million dollars Like if microsoft has kind of evaporated you

know what could happen More risks will haunt your sleep

in that the stock and suddenly gap down three dollars

on a bad quarter at which point Your spreads must

widen to accommodate expected further volatility in the stock And

you then compete with other specialists who also make a

market in microsoft Well at any given time they may

want to go get out of trading in it and

undercut you Buy any or to a share leaving you

as the sole big owner of what will feel like

a stock version of the titanic Well the math gets

complex is the market gets volatile specialists use hedges and

human beings end up competing against a i'd driven black

box computers But the reason you exist as a specialist

or rather the key job or responsibility of the specialist

is to provide liquidity That is you have to buy

and sell shares too Accommodate hey the market that's your

job and in volatile markets it means that they might

run out of inventory or be squeezed and have to

buy shares at much higher or sell shares at much

lower prices than their costs But that's the risk you

take when you become a specialist they must execute on

these trades and if they don't they lose Their seat

Is a specialist on the exchange altogether and are more

or less fully out of work And you know i

don't know Working for uber lift or something Next Yeah

And at that point well they might be willing to 00:06:31.755 --> [endTime] take just about anything for a ride