The spread you quote vs the spread you actually keep

Question

You quote a \0.10-wide market (half-spread \0.05 on each side). But on average, the mid drifts \0.03 against you in the moments after each fill (that's your average adverse markout). What is the "realized" (effective) spread you actually capture, versus the \0.10 you quoted? Why is the gap the important number?

Accepted Answer

The quoted spread is what you advertise; the realized spread is what survives after the market moves against your fresh position. Define, per side, the realized half-spread as the quoted half-spread minus the adverse post-fill drift: h{	ext{realized}} = h{	ext{quoted}} - (	ext{adverse markout}) = 0.05 - 0.03 = \0.02. Across a round trip (buy on the bid, later sell on the ask, or vice versa) that's a realized spread of \0.04, not the \0.10 you quoted. More than half of your advertised spread was given back to adverse selection. Why the realized spread is the number that matters: - It's your…

The spread you quote vs the spread you actually keep

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