Here are two professionals, arguably at the top of their game as announcers of Sunday Night Football.
Weekly, in season, millions of viewers learn more of the game, each game, through their instantaneous, live, real-time analysis of sometimes surprising events on the field of contest. They bring to the scene years of experience and familiarity with players and coaches, strengthened by daily, often informal, personal interviews. Their "back stories" behind the competitors' behaviors, both on the field and on the sidelines, enrich our experiences and entertainment.
Yet they typically are very disciplined in their treatments of everyone, as their roles demand. No doubt they beforehand have well-reasoned notions of the probable outcomes of every game they describe, but they maintain a rather evenly-balanced description of the evolving situation, up to the point of an obvious ending. Besides their being aware that the funny shape of a football can sometimes bring big surprises, I take this as a valid metric of their professional skills.
Investment market announcers?
There are observers and silent commentators in the investment field, parallel to Al and Chris. They are every bit as influential to the investment game as are Al and Chris to football entertainment, but to be effective, must operate quite differently. They are the market-makers [MMs].
While A&C broadcast to millions for hours at a time, the MMs typically are dealing with one or a very few clients to try to find a balance between the buy and sell sides of an order presented by a client, under very strict price and time constraints. "Fill or kill" is often the prevailing instruction; do it now, as presented, or forget it and get on with the next demand.
The activity involves knowing where there is volume of shares likely to either be available for sale, or in an appetite to purchase, and within what price bounds. Only infrequently do the two sides of the trade balance to a point where it will "cross" without help from an MM. The help involves putting capital from the MM firm at risk in a temporary long or short position to balance the trade. It is a process known as making market "liquidity" so that a transaction can take place at a price that will be recorded.
Thousands of such transactions take place in a typical market day. The skills parallel to those of A&C come partly in knowing the audience of owners or of potential purchasers of the subject stock or ETF, and persuading them to act in desired fashion, and partly in bargaining with the initiator of the trade order to get to a price for the entire "block" trade (which usually involves thousands, sometimes even millions, of shares), a price at which the deal can be printed.
Who are these market-makers?
Al and Chris have broadcast personae that are valuable to advertisers and the network. Quite contrary to that, the MMs need to be able to minimize the awareness of their presence in order to avoid resistances by the other potential parties in the trade. MMs rarely let it be known, even on the "street" exactly what their roles are, other than they work for "XY&Z Capital." If pressed they might admit to working on "the trading desk" or in "the back office."
If you had a job that paid as much or more annually than an average NFL player (7-figures), in an economy with over ten million people out of work, would you want to be bragging? In physically hazardous football, NFL stands for Not For Long. In market-making ALAYCP stands for As Long As You Can Produce.
How does a MM firm make profits?
One way MMs produce is by building block-trade deals that are virtually riskless, but guarantee the firm huge profits on the time and capital involved. They do it by hedging the capital put at risk, so that only good things are likely happen to them. This requires that they make astute judgments about just how far the deal subject's price might go, in each direction.
How can that happen? As Jacques Clouseau (aka Peter Sellers) responds in the movie Pink Panther, "It is my business to know these things." But the MMs typically do have a real advantage most of the time over the other parties involved in these big trades. Their advantage comes from two principal sources:
The MM firms, in previous decades, have built and maintained information-gathering systems world-wide, supported by cutting-edge-technology communications piped directly to the trading desks. The design is to keep from getting "bagged" by clients who may have come upon some non-public information yet to be released, and are eager to profit (or avoid a loss) from it. Some MM firms are reputed to see this protection and advantage as not being a two-way street, as far as the client (or the capital assets they manage) is concerned.
The other principal source of advantage is from the clients' actions themselves, known as "order flow." The MMs each are part of a community that is highly inter-communicative. A certain amount of sharing is viewed as part of the required "dues" for being in the club. While revelation of the specific source of trade orders is a street no-no, their existence, size, and time pressures for getting "filled" often leak out. The shorter-term perspectives provided by such information are not usually part of the Fund-money-manager side of the activity.
All of this becomes focused in the three-way negotiation required between the money-manager client attempting a trade, the MM that must be involved to reach a supply-demand balance at a price, and the seller of the price-protection hedging insurance that would make the balance possible.
Typically that protection-insurance seller is the "proprietary trading" desk of some other MM firm. For the right insurance premium paid, they will undertake the risk that the other MM must avoid. Both MM firms usually have similar knowledge and understanding of the deal subject's prospects. Both are intent on making as good a profit for their firm out of the deal as possible. Both know that because the cost of the insurance gets folded into the deal's overall trade spread, if it is too high the fund client may kill the deal and neither MM gets any profit.
Now we come back to the Michaels-Collinsworth parallel. In the course of the game the two announcers often have different reactions to the call of a game official or what appeared to actually have happened on-screen, or the wisdom of a strategy being undertaken by one team or the other. Law enforcement officials often have similar differences of perceptions by witnesses to the same event, and they rarely have any electronic replays to go by. So also may it be in the situations between MM protection-buyer and MM protection seller.
So who should we believe?
But if the block trade is to be done, some agreement must be reached, first between the MMs, and then between the money-manager client and his trade-facilitator MM. Just as A&C more often come to agreement than to agree to disagree, the hedging cost and structure will be agreed upon by buyer and seller of the protection. It is here in the MM communal agreement where is found the probable price change limits that exist for the subject stock, both now and during the period of protection being afforded. Price paid, and the structure created, tell the story of professional expectations agreed to.
Explaining what is agreed about is usually much simpler for Al and Chris.
But in fact, specific price change limits for the stock subjects can be inferred from these transactions in the listed options price change insurance markets. And for most actively-traded stocks and ETFs, it is the scale of these block-trade insurance protections that set the going contract prices in that market. And those prices and the deal structures define the knowledgeable expectations of the market-makers.
After performing this form of Intelligent Behavior Analysis daily for over a decade on many stocks we know which ones the MMs have good future price insights on.
We expect to continue to offer on Seeking Alpha specific stock and ETF insights into investing opportunities indicated by this approach so that they may become a part of do-it-yourself individual investors' due diligence and valuation explorations.