You are filled as a passive buyer of 1,000 lots at 50.00. The mid at the moment of the fill is 50.005. Sixty seconds later the mid is 49.97. Split the trade into spread capture and adverse selection and give the markout per lot.

You are filled as a passive buyer of 1,000 lots at 50.00. The mid at the moment of the fill is 50.005. Sixty seconds later the mid is 49.97. Split the trade into spread capture and adverse selection and give the markout per lot.

Approach: Measure the edge against the mid at the moment of the fill, then measure how far the mid travelled afterwards, and add the two with the sign of the position you were left holding.

-3 cents. At the fill you took the effective half spread of 50.005 - 50.00 = 0.5 cents of spread capture. The mid then moved 50.005 - 49.97 = 3.5 cents against a long position, so adverse selection cost 3.5 cents and the markout is 0.5 - 3.5 = -3 cents per lot, which on 1,000 lots is 3,000 cents, or $30 lost. Spread capture measured on its own would have booked this fill as profitable, which is why a fixed-horizon markout is the honest measure of a maker's edge. A book of fills with positive spread capture and negative 60 second markout means the flow is informed and the quote is too tight for it.

Follow-up: If the 10 second markout is -0.4 cents and the 60 second markout is -3 cents, what does the difference say about who traded with you?

Key concepts: markout, adverse selection, effective half spread, spread capture.