You've gotten short, which way do your quotes move?

Question

You make markets in a name you believe is worth $50.00$ . A run of one-sided flow has left you short $15{,}000$ shares, more than you are comfortable carrying. You still think fair value is exactly $50.00$ .

How do you set your bid and ask now, versus when you were flat? Explain the principle.

Accepted Answer

Shift both quotes up, the mirror image of skewing down when long. Flat, you might quote 49.98 / 50.02, symmetric around fair. Short 15{,}000 shares, quote something like 49.99 / 50.05: - Your bid at 49.99 is now aggressive (only 1 cent below fair), you are offering sellers a good price because a purchase reduces your short risk. You accept thinner edge in exchange for flattening. - Your ask at 50.05 is defensive, you will still sell more, but only if paid well for growing an already oversized short. Formally, your reservation price, the level at which you are indifferent to trading, drifts aw…

You've gotten short, which way do your quotes move?

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