Foundations · F2 · 7 min
Inside a trading floor
Know who does what on a trading floor and work out what a dealer earns from the gap between its buying and selling prices.
In the news: When you read that banks earned more from trading, or that dealers widened their prices, this is what is happening on the floor.
The essentials
- Desks and FICC
- A trading floor is split into desks by asset class: rates, FX, credit, commodities and equities. The first four are often grouped as : fixed income, currencies and commodities. Each desk is judged on its P&L.
- Who does what
- Sales looks after clients and brings in their orders; traders set prices and manage the risk; structurers design products for one client; quants build pricing models; research writes forecasts and trade ideas.
- Bid, offer and spread
- A dealer buys at its bid and sells at its offer; the gap is the . A quoted 99.96–100.04 is 8 cents wide per 100: sold to the dealer at 99.96, bought from it at 100.04.
- What a market maker earns
- A earns about half the spread per trade when client buying and selling balance: £10,000 on £25m at 8 cents wide. A move on what it holds can wipe that out: 0.10 on £50m is £50,000.
- Flow and structured
- Flow products (currencies, government bonds, plain swaps) trade in volume at thin spreads, much of it priced by algorithms. products are built for one client: more profit per trade, harder to hedge.
Dealer revenue from the spread
Revenue ≈ n × size × spread ÷ 2
- n
- number of client trades
- size
- notional of each trade
- spread
- bid–offer spread as a fraction of price: 8 cents per 100 is 0.0008
How it works
1. A shop that buys and sells
An airport currency kiosk buys your pounds at one price and sells them at a slightly higher one. It doesn’t need to guess where the pound goes next; it earns the gap. A bank’s trading floor does the same with bonds, shares and currencies, in millions at a time.
2. Bid, offer and spread
The price a dealer will pay is its bid; the price it will sell at is its offer. The gap between them is the . A bond quoted 99.96–100.04 can be sold to the dealer at 99.96 or bought from it at 100.04: a spread of 0.08 per 100.
3. Half the spread on each trade
If clients buy and sell in equal amounts and the price stays put, the dealer earns about half the spread on each trade: 0.04 per 100 against the 100.00 middle price. On £25m that is £10,000. A dealer that does this all day, always ready to buy and sell, is a .
4. The risk between trades
The catch is the wait. A dealer that buys £50m of bonds owns them until another client wants them. If the price drops 0.10 in the meantime, it loses £50,000: many trades’ worth of spread. Wider spreads earn more per trade but win fewer trades, because clients compare prices from several dealers.
5. Desks by asset class
A trading floor is split into desks by what they trade: rates, FX, credit, commodities and equities. Banks often group the first four as , short for fixed income, currencies and commodities. Each desk has limits on how much risk it can take and is judged on its profit and loss, its P&L.
6. Sales and trading
Salespeople look after clients: they call pension funds and hedge funds with ideas and bring their orders to the desk. Traders set the prices and manage the risk that results. A trade needs both: one knows what the client wants, the other what the bank can offer.
7. Structurers, quants and research
Structurers design products for one client’s needs, such as a note that pays more if a share index stays above a level. Quants build the maths and code the desk prices with. Research writes forecasts and trade ideas for clients.
8. Flow and structured
Standard products traded all day in volume, such as currencies, government bonds and plain swaps, are flow: thin spreads, many trades, and much of it now priced by computers in milliseconds. Products built for one client, often with options inside, are : more profit per trade, but harder to price and hedge.
Worked example
A dealer quotes a 10-year gilt 99.96–100.04, a spread of 8 cents per 100. It trades 30 tickets of £25m in a day, half buys and half sells, and the mid ends where it started.
- Spread = 0.08 points per 100 of face value, or 8bp.
- Half the spread per trade: 4bp × £25m = £10,000.
- 30 trades × £10,000 = £300,000 of spread revenue.
- Had the mid fallen 0.10 while the desk was long £100m, the inventory loss would have been £100,000: a third of the day’s spread.
About £300,000 from the spread, which a modest move against the inventory can quickly eat into.
Check yourself
8 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
What does a market maker actually earn, and what risks come with it?
Sales or trading for you, and why?
How has electronic trading changed the junior trader’s job?
Remember
Revenue ≈ trades × size × half-spread
A market maker earns about half the spread on each trade, as long as prices don’t move against its inventory in between.