Discussion round for trading roles.
How wide should the spread be?
The question
What determines how wide you quote?
Have a go before you open the solution. If you are stuck after a few minutes, the first paragraph below is usually enough of a nudge.
Show the worked solution
The answer
Volatility, the chance the counterparty is informed, your inventory, the size shown, and what competitors quote.
Uncertainty about fair value sets a floor: the more the value can move before you can hedge, the wider you must be.
The probability of an informed counterparty adds to that, because the loss to informed flow must be paid for by the spread earned on uninformed flow.
Inventory shifts the centre rather than the width, and size scales both, since a larger clip is harder to unwind.
Competition pulls the other way: a spread wider than the market earns nothing because you never trade. The honest answer names the tension rather than listing one factor.
What it is testing
Whether you can hold several competing forces at once instead of naming one.
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Preparing properly
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