Which of the following tends to widen the spread a market maker quotes?
Quiz: Trading
Last reviewed: September 26, 2026
This is a draft, shown for review before publication.
3 questions to check your understanding of the chapter “Trading”. Choose an answer and select “Check answer” to see the answer and explanation. You can also open “Answer and explanation” to see the answer first.
Question 1
Answer and explanation
Answer: A
A higher chance of trading with informed counterparties widens the spread. If the counterparty knows the direction of the price move in advance, the market maker ends up on the wrong side of the trade, and its results lean toward losses (adverse selection risk). The market maker expects losses when it trades with informed counterparties and quotes a wider spread to cover them.
In the models in the research, the spread widens when the cost of holding inventory on the balance sheet or the cost of trading with other dealers rises. A fall in these costs does not work toward a wider spread. More trades do not work toward a wider spread either. For issues that trade rarely, and so offer few chances to earn the spread, the cost of adverse selection built into each trade is thought to be larger.
Learn more: Market Making
Question 2
Which of the following is true of a primary market maker (PMM) under the Market Maker Program of Osaka Exchange, as applied from August 3, 2026?
Answer and explanation
Answer: C
A PMM can temporarily stop making markets because of market conditions, trading conditions or system issues. Since conditions are imposed, it is easy to assume that failing to meet them brings a penalty, but there is no direct penalty for failing to meet the conditions. However, incentives may be reduced. The exchange may also revoke the designation if it judges that the fulfillment rate is extremely low with no prospect of improvement.
A PMM keeps quoting bids and asks in line with conditions set by the exchange. It is therefore easy to assume that it must always quote when asked, but when a request for quote is sent through the trading system (J-GATE), a PMM may choose whether to respond. Apart from PMMs, there are also LPs, which place quotes within a range they judge appropriate. As a rule, a firm can apply for only one of the two roles, PMM or LP, for the same product.
Learn more: Market Making
Question 3
As a hypothetical example, you sell a variance swap with a strike of 20% (400 in variance terms) and a vega notional of 1 million yen per volatility point. The seller's payoff is the variance notional × (400 − realized variance), and the variance notional is the vega notional divided by (2 × strike). Realized volatility turns out to be 24%. What is the seller's payoff?
Answer and explanation
Answer: B
The payoff is a loss of 4.4 million yen. The variance notional is 1 million yen ÷ (2 × 20) = 25,000 yen. Realized variance is 24 × 24 = 576. The seller's payoff is 25,000 yen × (400 − 576) = −4.4 million yen.
A loss of 4 million yen is the 4-point volatility difference times the vega notional of 1 million yen. A variance swap pays on the difference in variance, not volatility, so losses grow faster as realized volatility rises. A gain of 4.4 million yen has the sign reversed. The seller pays when realized variance exceeds the strike. A loss of 8.8 million yen takes the variance notional as 1 million yen ÷ 20 = 50,000 yen, forgetting the factor of 2 (50,000 × (400 − 576)).
If realized volatility is 16%, realized variance is 256, and the seller's payoff is 25,000 yen × (400 − 256) = 3.6 million yen, a gain. The gain is capped at 25,000 yen × 400 = 10 million yen, which occurs when realized volatility is 0. The loss grows as realized variance rises and has no cap.
Learn more: Volatility Trading