A market maker quotes both buy and a sell prices in order to profit from the spread between bids and offers and also from the spread between a price quoted and a reference or theoretical price.
The bid-offer spread is the difference between the highest buy prices and the lowest sell prices. For example, a market maker might quote a bid price of $1 and a offer price of $2. This means customers can either sell at $1 or buy at $2. The goal of a typical market maker is to post prices that will attract interest on both sides of the market (prices that attract buyers and sellers) and therefore profit from the difference between those who buy and those who sell.
A market maker can also price their market based on a benchmark or reference price. This price could be a liquid benchmark or a theoretical price. For example, if a merchant can buy goods for $1 from a supplier, while transportation, storage, and other costs come to 20 cents, they might be willing to sell to local customers for $1.50, which would guarantee the merchant a profit of 30 cents. If the supplier’s price changes to $1.30, then the merchant might choose to adjust their retail price to $1.80 to ensure the same profit margin, even if the merchant doesn’t buy any more goods from the supplier in the meantime.
A bookie quoting betting odds is also a type of market maker. Even without making trades with other bookies, a book maker can use the odds competitors are posting to set their own prices. If a large Las Vegas casino is quoting the Yankees to win the World Series at decimal odds of 20, the local bookie might offer odds of 15. Although this wouldn’t guarantee a profit for the bookie, it would provide a betting market for local customers. If the local bookie can post odds for a variety of baseball teams, they might be able to attract bets on many teams teams and therefore get closer to making a constant spread on all customer bets.
