Before going into a detailed discussion about the Market Makers in India, it is very important to know what exactly market making is all about. Market Making is basically aimed to inculcate liquidity in securities that are not really frequented on stock exchanges. Typically, it is the market maker, who is responsible for enhancing the demand-supply situation in securities which is inclusive of stocks, futures and options (F&O). Having an idea of the existing screen based electronic trading system could be helpful to understand the concept of market making better. By this system, orders are successfully placed by the buyers and sellers, which are matched by the computer system.
However, this system is extremely beneficial for the actively-traded stocks, whereas lesser traded ones are not really affected by the system. Most of the times, investors are not really interested in thinly traded stocks in spite of good fundamentals, with the fear that those items might not get traded frequently. In such a situation, market makers creep in. Market making is solely done to infuse liquidity to lesser traded shares. Market maker is typically an institution or a broker, who gets an incentive to recommend the securities to the investors and thereby creating a market for the lesser traded options.
The ways of Market Making
A market maker is the one who is meant to enhance and increase activities in less traded shares futures and options. In the ways, the market maker gives the buy and sell quote at the same time for the security option he chooses. The market maker himself gets benefitted from the spread between the buy and the sell quotes. As for an instance, if the market maker provides a quote of Rs 310-300, this actually means the market maker will buy at Rs. 300 from the market and would sell it at Rs.310, in between there is a profit of Rs. 10, which goes to the market maker. In cases of the illiquid securities, there are high risk involvements and hence the profit spreads are higher for the market maker.
Market makers are compelled to buy or sell the security at a stipulated price they have quoted. The role of the Market maker is often questioned in the era of computerized system, as investors can buy securities without any third party as well. Here, it is important to note that in case of the computerised system, the market makers ensure supply of stocks at any given point of time. As long as investors are willing to pay for the securities as per the price quoted by the market makers, they are ready to buy and sell the securities.
Advantages of Market Making
Market Makers can skilfully analysis the security options, which eventually speaks in favour of the company
It could be the continuous source of liquidity for the company’s scrips
With the Market makers on your side, it is easy to provide valuation for the company’s scrips.
Having the support of the Market making and market makers, investors can liquidate his investment at any time he chooses to
The stiff competition amongst the market makers often results into efficient pricing
Markets makers could be the source of company information
Types of Market Makers
There are basically two types of Market makers in the market:
Principal Market Makers (PMM):
Principle Market Makers offer buy and sell quotes for a period of almost 18 months from the commencement of the initial trading
Additional Market Makers (AMM):
Additional Market Makers normally buy and sell quotes for a period of almost one year from the actually commencement of the initial trading
The significance of the Market Makers in the Indian Financial Market
Due to lack of liquidity, investors are not willing to invest in several sectors of the market, this includes many small and mid cap stocks and equity derivatives. There have been numerous cases in past, where the investors are unable to gain exit from several small and mid cap stocks while correction, due to the absence of buyers who are interested in it. Hence, in such a scenario, market makers can buy the stock at the quoted price.
However, many a times, experts have denied the significance of the market makers, as they find, the presence of the later distort the natural market conditions. The market makers act as the wholesalers by buying and selling securities, experts felt that the prices would not affect the demand supply scene.
The concept of Market Makers in India
In the March of 1998, SEBI (Securities and Exchange Board of India) constituted a committee under the chairmanship of GP Gupta, who proposed the idea of having Market makers who could improve the liquidity of the illiquid shares. The committee, working under Gupta put forward several proposals and recommendations in this regard.
The concept of market making was first adopted In India by Over the Counter Exchange of India (OTCEI), a stock exchange that comprises of small and medium sized firms. Nevertheless, the venture failed within no time. Instead, brokers willingly chose to be the market maker for the illiquid stocks, for the high percentage of profit involve with it.