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Choosing Micro-Price or Separate Fair Values for Market Making

Article Quant Q&A · Author: Ted Graham
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Summary

The document compares using one size-adjusted micro-price to guide both sides of a market-making quote with maintaining separate bid and offer fair values. Its examples use futures order-book prices and displayed sizes: the micro-price shifts toward the side with less displayed volume, while separate side values can track the quoted spread and widen when the book widens.

The response cautions that a size-adjusted value should not be confused with intrinsic fair value or an executable market price. Moving a bid or offer inward can imply a trading price unavailable in the book, making the adjustment unsuitable for arbitrage calculations. One practitioner favors ordinary bid and ask prices for easier interpretation, while acknowledging use of size-adjusted mids by other traders. The discussion is a practical opinion rather than a tested comparison, and it gives no performance evidence or general rule for choosing between approaches.

Key ideas

  • A single size-adjusted micro-price can serve as a common reference for both quote sides.
  • Separate bid and offer reference values can reflect changes in the displayed spread.
  • A size-adjusted price may imply execution at a level the market does not offer.
  • The response recommends caution and notes that plain bid and ask prices are easier to interpret.

Tags

FuturesMarket makingMarket microstructureExecution
Full text
# Should a high-frequency market-making fair value be a point or bid/offer pair?


# Should a high-frequency market-making fair value be a point or bid/offer pair?












A single micro-price (e.g., volume weighted mid adjusted for recent trades) is simpler and can be used for pricing both our bid and our offer.

But a bid fair and an offer fair have the desirable property that they widen out automatically as the market goes from one tick wide to five ticks wide.

As an example, given a futures book of 20 @ 6.01 / 6.03 @ 50 we would have a micro-price of 6.016 (since the bid has less volume) or a bid & offer fair of 6.012 & 6.026 (again, the bid is weaker).

Which approach is better and why?

EDIT: The above example shows two choices, a single micro-price of 6.016 or a bid/offer pair of 6.012 / 6.026.

If the market widened to 10 @ 6.01 / 6.09 @ 10, the choices would be a single micro-price of 6.05 or a bid/offer pair of 6.01 / 6.09. That shows one of the main advantages of using a bid/offer pair, they widen automatically as the market you are pricing gets wider.

## Answer by chrisaycock (score 1)

https://quant.stackexchange.com/a/50199

I would hesitate to call a size-adjusted price the "fair". There was some confusion in the comments since a "fair" is the intrinsic value, such as the NAV of an ETF.

I am also concerned with any manipulation of a quote that brings the bid and ask inwards. Your example converts 6.01 to 6.012, which would indicate that I could sell my own contract to the market for that rate, which is false. An arbitrage calculation must not use a price that is better than what the market will allow.

That said, I personally have seen traders who use size-adjusted mids, but I find them really difficult to reason about, especially when the market is volatile. I just use the regular bid and ask since that makes everything easier.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.