[huhnmonster]

I guess I understand where you are coming from, but they way I understand it is that RH submits a bulk order for a stock and gets a quote from the MM, which the MM thinks is appropriate. The MM then adjusts its own portfolio accordingly, buying/selling the underlying stock at its own pace.

So, more or less as described, but the order is a little different, right?

[ivalm]

Market makers fulfill a bunch of orders, they then have until end of day to get into a delta neutral position. They prefer to trade against retail traders because retail traders are typically uncorrelated, which means that vast majority of trades cancel out (but MM still collects the bid-ask spread on the trades!). When you make markets for counter-parties that include big institution there is always a risk that the "small" trades you're fulfilling will be very correlated (because a big institution is actually breaking-up and feeding you a big trade). This is called adverse selection and will force MM to start buying to get to a neutral position (which means that the bid-ask spread they are collecting will have to be paid to some other seller).

What Citadel and others are doing is they are saying to RH "your order flow is uncorrelated and we'd like to make markets for it, we will charge your users slightly lower bid-ask spread (price improvement for user) and we will also give you a slice of the bid-ask spread we do collect, in return the uncorrelated nature of the orders will ensure that we won't have to do much trades in order to maintain a neutral position."

This proposition is actually good for

1. RH users (they get price improvement relative to NBBO)

2. RH (they get to make money and get a user base)

3. Participating market makers (they get much steadier cash flow from MM activity).

It is bad for

1. Big institutions, they get to pay larger spread than they would if the market was more diluted by retails

2. Non-participating MM (they increase the bid-ask spread to make sure it's still worth their time but there is more volatility and it's a competitive market so mis-pricing the spread is a real problem).

Also, current GME shenanigans are net good for MM since MM is a business that makes money on volume, not direction.