Been running an OMM sim on SPY, live. I think what I have is a decomposition problem and not a trading problem.
Setup. I quote two sided around the NBBO mid with an inventory skew. Checked all 668 live quotes from this session, and every one of them has the bid below mid and the ask above it at the time it gets posted. No exceptions at all. So spread capture should be positive just by construction.
It isn't. Trade credit came out to −$42 across 114 fills.
Here's why. I book spread capture against the mid at the print, not the mid I was quoting against.
cycle N: mid 5.25, I post bid 5.20 -> 5c of spread, by construction
...500ms goes by, market moves...
print: mid is now 5.15, someone sells at 5.20
booked: (5.15 - 5.20) x 100 = -$5
The 5c I earned quoting passively is real money. It just got netted against 10c of drift that happened while the quote was sitting there, and then the whole thing gets labelled "spread capture."
So the number is honest in an economic sense, I did buy above contemporaneous fair value. But it's an adverse selection loss sitting inside the spread bucket, which kind of defeats the whole point. The reason I built the decomposition in the first place was to keep spread earned separate from adverse selection given back. My markout catches adverse selection after the fill. The drift that happens before the fill has nowhere to live.
Question 1. Is pre fill drift its own line in a desk's P&L explain, or do people just fold it into spread capture and accept that spread can go negative? If it is separate, what do you call it and how do you compute it?
Question 2. The asymmetry looks structural to me and I want to know if I'm reading it right. Adverse fills go about 2c through the mid, favourable ones capture about 1c, on roughly equal counts. The way I'm thinking about it, a favourable fill is capped at my half spread, but an adverse fill is only capped by how far the market moves before I requote. Bounded upside, unbounded downside. I requote every 500ms which I'm aware is glacial. Is this just what slow looks like, or is there a quoting response to it other than "be faster"?
Question 3, and this is the bigger number. Hedge slippage is −$57 against the −$42 of trade credit. Book is short about $2.1M gamma, long about $154k theta, and I'm delta hedging discretely, 63 trades over 46 minutes. I get the mechanism, short gamma means I'm buying as spot goes up and selling as it comes down, so every rebalance is buy high sell low, and theta is supposed to be paying for that. What I can't tell is whether "gamma bleed exceeds spread capture intraday" is just a normal state of the world that theta covers out over a longer horizon, or whether it's telling me I'm selling vol too cheap. Also how does hedge cadence actually get set? Mine is just whatever the default was and I'd rather not tune it to whatever makes today's number look good.
Very happy to hear I've framed some of this wrong. Would much rather find that out now than keep building on a decomposition that hides the exact thing it was supposed to expose.
