The edge you need just to cover fees and adverse selection

Question

You're deciding whether to quote a name. Per share, you expect to pay an exchange/clearing fee of $f = \$ 0.005 $, and you estimate adverse-selection cost of$ a = $0.02 $per fill. The market's current half-spread is only$ h = $0.02$.

What half-spread do you need to break even, and should you quote at the current market?

Accepted Answer

Your expected profit per share is the half-spread you capture minus everything that eats it: \mathbb{E}[	ext{PnL}] = h - a - f. To break even you need h \ge a + f: h{	ext{break-even}} = a + f = 0.02 + 0.005 = \0.025 	ext{ per share.} The current market only offers a half-spread of h = \0.02, which gives \mathbb{E}[	ext{PnL}] = 0.02 - 0.02 - 0.005 = -\0.005 	ext{ per share.} So quoting at the current market loses half a cent a share, you'd be providing liquidity below cost. Two honest choices: 1. Don't quote at the inside. Only post when the spread is at least \0.025 wide (quote back / st…

The edge you need just to cover fees and adverse selection

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