Inventory Offsets and Quote Retreats in Options Market Making
Summary
The document explains two quote adjustments used in high-frequency options market making. An offset shifts a quote away from its theoretical price to account for inventory: a market maker holding too much of an exposure can skew prices to encourage trades that reduce it. The response gives a simple relationship between quote price, inventory, and a risk factor, but does not specify how to estimate that factor or handle different option risks.
A retreat widens the bid-ask spread or temporarily removes quotes when volatility or potentially informed order flow makes trading riskier. The explanation distinguishes managing existing inventory from limiting exposure to adverse market conditions. These are broad descriptions rather than a detailed pricing model: the document offers no empirical evidence, calibration procedure, or account of how firms combine the adjustments. It also does not define the separate variations, such as trade retreats and quote retreats, beyond mentioning them in the question.
Key ideas
- An inventory offset skews theoretical prices to encourage trades that reduce a market maker’s position.
- A retreat widens quotes or withdraws them when volatility or adverse selection risk rises.
- Offsets address inventory exposure, while retreats limit exposure to dangerous market conditions.
- The document gives a conceptual explanation but no calibration method or empirical evidence.
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Full text
# In the context of HFT options trading and market making, what do the terms Offset and Retreats mean?
# In the context of HFT options trading and market making, what do the terms Offset and Retreats mean?
Talking to people that work at large options market makers, they frequently use terms like offsets and retreats when talking about option pricing.
There also seems to be variations of them like:
- Trade retreats
- Quote retreats
and they continually need to be updated as time progresses and the market evolves during the day, at least the retreats do. They seem to need a retreat model, which then adds even further confusion.
My question(s) would be, what are they and what is their purpose in terms of option pricing and how are they calculated?
Any reading material or references would be appreciated.
## Answer by Jien Weng (score 3)
https://quant.stackexchange.com/a/85467
In HFT options market making, these terms usually refer to dynamic adjustments to your quote price and spread to manage risk.
#### 1. Offsets
Offset is about shifting your theoretical mid-price to handle inventory risk.
If you are long too much delta (holding too much inventory), you want to sell. So you "offset" your price lower to attract buyers. The idea is to skew your price so you passively unwind your position back to neutral.
The logic is roughly: $$ \text{Quoted Price} = \text{Theoretical Price} - (\text{Inventory} \times \text{Risk Factor}) $$
#### 2. Retreats
Retreat (or fading) is about widening your spread or pulling quotes when the market gets dangerous.
If your model sees increased volatility or toxic order flow (informed traders), you retreat to avoid being picked off. This can mean widening the bid-ask spread (e.g., from 5 cents to 10 cents) or even briefly canceling orders until things calm down.
Basically, offsets lean the price to fix your inventory, and retreats widen the price to survive volatility.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.