Understanding Jane Street

Re EA: quoting my boss, EA isn't really a dominant thing in the market maker space, it's pretty much only espoused by a couple high profile individuals (mainly, SBF).

Re strategy: point about how there's little strategy involved in being a market maker is off-base. Everything is ultimately strategy: do I continue to pour resources into a strategy that is losing money in the hopes of eventually seeing pnl? What markets should I focus on? What is the best use of time for each employee that maximizes pnl/head? etc etc

One thing that I thought article got right is that most work involved in market making is about avoiding trades, not making them. Capturing the bid ask spread is conceptually easy. The hard part is avoiding trading with toxic counterparties.

Part about put options is especially apt. Market making during a crash / recession (like right now) is especially difficult because all the non-toxic counterparties have stopped trading as much (people like to trade a lot more during a bull market than a bear one). By setting up a structure such that you profit during a crash (either by buying puts, leaning net short, or through some other method), you introduce an uncorrelated return stream that can really help.

2. You have to solve over the phone very hard math questions to make it past the initial screening stage. I dunno what comes after that.

The highest-stakes gambling events in the world are typically very discreet, invite-only affairs. One that might be close to the top in terms of available winnings happens at the end of Jane Street internships: interns get a stack of 100 poker chips and spend half a day getting asked brainteasers and then betting on their confidence in the answers. Some of these questions might be pure math and probability questions, some might be more abstract bets on making a market in some outcome, and apparently one of the questions is a tough probability question where part of the prompt is to bet on how long it will take to get the answer.1

I dunno why brain teasers are so important. I increased my account by 5x since the lows of covid to present with simple large cap tech and etf strategies (tesla ,tqqq, tecl, amazon, and others ). I don't need to mentally visualize 3d shapes intersecting 2-d planes or count colored vertices of hypercubes to make money or develop good strategies. Just some basic calculations and some other analysis..maybe advanced high school level. It's like if you want to find good traders, look for people with good track records.

If I were going to start a fund, I would do away with the puzzles. Instead what I would do is look for people who seem to have good track records on reddit or elsewhere and some decent risk management, like on wallstreetbets. There are thousands of users there and then I would try to find the best ones and try to quiz them on risk management to see if they are relying on luck or have a system. Recruiting from reddit or twitter is harder than linkedin, but I think the quality is better because you are seeing actual traders in their element. instead of hoping that puzzle skill will lead to trading skill, you just pick people who are already good.

Continued:

The other mitigation strategy is: just buy some puts. Markets usually don't crash upwards, but they do have a habit of crashing downwards. And for a market-maker, a crash is a uniquely interesting situation: volume is high, spreads rocket up because people are afraid to trade or don't have the liquidity, so an active participant can make a staggering amount of money. (I liked this Reddit AMA: "Yeah, 08-09 was insane. I've heard stories. No one knew what the fuck was going on and everyone was on edge. Then it all turned out fine and everyone got PAID.")

Puts bleed out a lot. Even during bear markets they lose money if the path dependency is unfavorable. The covid crash would have been perfect, but the 2022 bear market has been much more gradual, so puts would have done more poorly.

Yes, the 'crashing down' aspect is captured by the skew or smile. That's why a 20% ITM put will have a much higher IV than a 20% OTM call or be much higher than predicted by the volatility of the underlying. In some cases it will be massive...like a 38% IV compared to 11% for the underlying. So many people have tried to make put strategies work, and I have yet to see anyone do it, but if someone actually could I imagine they would not tell.