You captured the spread and still lost money

Question

You sell 1{,}000 shares at your offer of 50.05 (mid was 50.00), so you're short 1{,}000. Before you can buy back, the mid rallies to 50.10, and you cover by lifting the offer at 50.12. Walk through the P&L. You "earned the spread" on both trades, how did you end up losing?

Accepted Answer

Trace the two trades. You sold high and then bought, but at what prices? 	ext{Sold } 1{,}000 	ext{ at } 50.05, \qquad 	ext{Bought } 1{,}000 	ext{ at } 50.12. 	ext{P\&L} = (50.05 - 50.12) 	imes 1{,}000 = (-0.07) 	imes 1{,}000 = -\70. You lost \70, despite each leg looking like good market making. Where the "spread capture" went. Break each trade into spread earned vs. adverse move: - The sale at 50.05 was 5 cents above the then-mid (50.00), a genuine +5-cent half-spread. So far so good. - The cover at 50.12, however, was made when the mid was 50.10, you paid 2 cents above that mid to ta…

You captured the spread and still lost money

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