You capture 1.1 cents of half spread on 2m shares a day of maker volume with a 10 second markout of -0.8 cents. A new participant arrives and your markout worsens to -1.4 cents. By how much must the quoted spread widen to restore the old margin, and what does that do to your volume?

You capture 1.1 cents of half spread on 2m shares a day of maker volume with a 10 second markout of -0.8 cents. A new participant arrives and your markout worsens to -1.4 cents. By how much must the quoted spread widen to restore the old margin, and what does that do to your volume?

Approach: Set the new half spread so that half spread plus markout equals the old margin, double it to get the quoted spread, then ask what the wider quote does to the fill rate.

1.2 cents. The old margin was 1.1 - 0.8 = 0.3 cents a share, and restoring it against a -1.4 cent markout needs a half spread of 1.7 cents, which is 0.6 cents wider, so the quoted spread widens by 1.2 cents. Volume does not survive the move: at a wider quote you sit behind anyone still showing 1.1 cents, so the fill rate falls, and if volume drops from 2m to 1.2m shares the daily gross falls from $6,000 to $3,600 even at the restored margin. The alternative is to hold the old spread on smaller size and accept a lower fill rate on better selected flow. Either way a participant with better adverse selection control takes the margin, which is why markouts are monitored per counterparty and per venue rather than in aggregate.

Follow-up: Your markout worsens only in the first 200 milliseconds after a futures move. What change do you make instead of widening the quote all day?

Key concepts: markout, half spread, quoted spread, fill rate, adverse selection.