The DMM Acting as a Principal

In the absence of public orders the  DMM is required to provide liquidity and price improvement for the stocks in which they are the designated market maker. DMMs are required to trade against the market but may now trade for their own account at prices that would compete with public orders.

Example:

If the public market for XYZ is quoted as follows:

Size

Bid

Offer

10 X 10

20.45

20.55

There is a 20.45 bid for 1000 shares and 1000 shares offered at 20.55

If a public sell order came in to sell the stock, the DMM could  purchase the stock for their own account at 20.45 because they are on parity with the public. The DMM could also purchase the stock for their own account at 20.50 and would be improving the price that the seller would be receiving. This is known as price improvement. Alternatively, if a public buy order came in, the specialist / DMM could  sell the stock from their own account at 20.55, because they are now allowed to compete with the public. They could also sell the stock to the customer at 20.50 because, once again, that would be providing price improvement for the order.

 

THE DMM ACTING AS AN AGENT

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