What your overnight book is really risking

Question

It's the close and you're still long 10{,}000 shares of a stock whose overnight return has a standard deviation of \1.50 per share (the typical gap from tonight's close to tomorrow's open). Over the day you earned roughly 2 cents of spread per share on the flow that built this position. How big is your overnight risk in dollars, and how does it compare to what you earned? What should you have done?

Accepted Answer

Size the overnight risk. Holding 10{,}000 shares with a per-share overnight standard deviation of \1.50: 	ext{one-sigma P\&L swing} = 10{,}000 	imes 1.50 = \15{,}000. That's a typical overnight move. A two-sigma night, not rare, would be \30{,}000 in either direction. Compare to the spread you earned. You collected about 2 cents per share on the way in: 0.02 	imes 10{,}000 = \200. So you're risking a \15{,}000 one-night swing to protect \200 of realized spread. The risk dwarfs the reward by roughly 75	imes at one sigma. Holding this position overnight is not "letting your edge ride", it's…

What your overnight book is really risking

Your answer

More Market Making questions