IPO Market Maker

OTC Market Makers

The market maker is a firm that “makes a market” in your stock. It does this by posting quotes on the prices at which the market maker will buy and sell your stock.

The bid price is the price at which the market maker will buy and the offer is the price at which the market maker will sell.

The difference between the bid and the ask is the spread.

If the market maker will buy at $10, that is the bid and if the market maker will sell at $10.15, that is the offer. The spread is the difference, or $0.15.

The market maker will compete with other market makers to trade the stock. Market makers wanting to buy will quote higher prices and market makers wanting to sell will quote lower prices.

For example, if there are two market makers, one could be quoting $10.00 bid, offering at $10.15, while the other is bidding $10.05 and offering at $10.20.

The highest bid of all market makers, combined with the lowest offering of all the market makers is known as the “inside market.” In the example above, the inside market is $10.05 – $10.15.

Market makers should not be quoting the same bid as another market makers offer. If the do so, the market is said to be locked.

Trading IPOs – Trading New Issues

The trading of new issues is a very exciting business. Several players combine to make this one of the more competitive and chaotic trading activities.

First, the underwriter or underwriters of the IPO will generally have a trading department that will make a market in the stock. The other players will follow their lead most often. The underwriter will have a supply of stock, and may have actually shorted the stock to have buying power to support it if the offering is expected to be at all weak.

When I was running the trading department of a Wall Street underwriting house, we did not have many retail sales persons to soak up the stock. Therefore, we had to judge if we were going to short or not. We would do short simply by overselling the stock. That is, if we has one million shares to offer, we could place 1,200,000 and be short 200,000.

If we went short a substantial amount and the stock was surprisingly strong, we would lose our shirts. If we did not go short and the stock tanked, we could only support it by using our capital, not something we enjoyed.

One time the underwriting department released the stock for trading without telling me on the trading desk. The short sellers and everyone else took this as a sign of amazing weakness and started dumping the stock in my absence. By the time I found out what was going on and started buying, we soaked up enough of our capital to almost put us out of business.

When the stock starts trading, the IPO flippers, those in there for a quick turn, will be in there selling. If the shorts see the stock as weak, they will also be in there selling in size.

Hopefully, the underwriter did not fill all the indications of interest to buy the stock it has, leaving some people to buy in the aftermarket. These people will be buying blocks of stock.

Therefore, the first hours of trading will be chaotic, frantic and filled with large trades, a trader dream.

Generally, we wanted to open the stock at a small premium to the offering price and after soaking up the supply provided by the flippers, start bidding to buy the stock at higher and higher prices. The ideal thing was to be able to cover any short we had at prices near the offering price.

If the stock was weak, and trying to go below the offering price, we could use our short and any customer buy orders to hold the line and keep the stock supported. Any sign that we were not able or willing to supportive the price would be taken as a sign to dump the stock.

It is important to underwriters that the stock stay above the offering price if they want to have demand for their later issues.

Short Raiding Initial Public Offerings

If the shorts can break the back of the offering and drive it down below the offering price, then all hell may break lose as massive dumping by short term trader, flipper and shorts kick in fast.

Vonage was a very smart short raid of a new issue.

Vonage was a classic bear raid. Vonage had millions of customers and decided wisely to offer the stock to the customers in their initial public offering. They automated the process of buying stock on the Internet and invited their customers into the deal.

Unfortunately, the shorts correctly reasoned that these small holders would be subject to panic if the stock went down. When the stock hit the market, they ripped the bid apart and the result was a precipitous drop in Vonage's stock price and huge profits for the shorts. The little guy, as always, lost money.
The Rules of a Market Maker
As a market maker, FINRA requires you to trade at the prices you quote. You cannot back away from the price you have set. You are also required to trade a minimum amount of stock at that price. The exact number of shares you must trade varies according to the price of the stock.
FINRA members may not trade for their own account at prices that are equal to or better than the prices of limit orders that they have received from their customers or from another FINRA member firm on behalf of its customers.

Within 90 seconds, the market maker must report a transaction to FINRA’s OTC Reporting Facility,

Market makers report their short interest positions at the middle and end of each month. FINRA applies short sale delivery requirements to those equity securities not otherwise covered by the delivery requirements of SEC Regulation SHO. Reg. SHO applies to all securities of all reporting issuers whether listed for trading on an exchange or quoted in the OTC market, including non-reporting OTC Equity Securities. These rules are supposed to limit abusive naked short selling.

To initiate quotations in any OTC Equity security or resume quotations after a four day absence or SEC suspension, a market maker must first file with FINRA the information on issuer required by SEC Rule 15c2-11. This is to make sure that minimum public information is available on the company before the stock trades.

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