Acquired average spread

What Is Acquired Average Spread?

Acquired Average Spread is an Execution Quality metric utilized in financial markets to assess the actual cost incurred by an investor when executing a trade, taking into account how the market price moves after the order has been filled. Beyond the immediate bid-ask spread, this metric provides a more comprehensive view of trading expenses by capturing the temporary price impact of a trade and potential costs stemming from adverse selection. The Acquired Average Spread is vital for evaluating how effectively a broker-dealer upholds its best execution obligations, as it offers insights into the overall transaction costs associated with securities trading.

History and Origin

The analytical concept behind Acquired Average Spread, particularly its emphasis on "realized spread" and post-execution price dynamics, gained prominence with the evolution of regulatory frameworks aimed at increasing transparency in trade execution. In the United States, significant developments occurred in the early 2000s, notably with the Securities and Exchange Commission's (SEC) Rule 605 (formerly Rule 11Ac1-5). This regulation mandated broker-dealers to publish monthly reports on their order execution quality, including various statistical measures like effective spreads and realized spreads. These mandates fostered a deeper analysis of how trades impacted market prices and whether investors truly received the most favorable terms, pushing firms to consider the spread "acquired" or "realized" by a trade beyond just the static quote at the time of order entry. Some market participants raised objections regarding the specific statistical measurements, such as "average realized spreads," in these mandated reports, citing concerns about potential biases.⁶

Key Takeaways

• Acquired Average Spread quantifies the comprehensive cost of a trade by including the impact of post-execution market price changes.
• It serves as a critical metric for Execution Quality assessments, reflecting a broker's proficiency in minimizing implicit trading costs.
• The metric is particularly effective at identifying and measuring costs related to adverse selection and temporary market impact.
• A lower Acquired Average Spread generally indicates superior execution outcomes and reduced overall trading expenses for the investor.

Formula and Calculation

While "Acquired Average Spread" is a descriptive term often used to refer to an average of "realized spreads," the calculation for a single realized spread, which forms the basis of this average, is as follows:

For a buy order:
$\text{Realized Spread} = 2 \times (\text{Execution Price} - \text{Midpoint Price}_{\text{post-trade}})$

For a sell order:
$\text{Realized Spread} = 2 \times (\text{Midpoint Price}_{\text{post-trade}} - \text{Execution Price})$

Where:

• (\text{Execution Price}) is the price at which the market order was filled.
• (\text{Midpoint Price}_{\text{post-trade}}) is the midpoint of the National Best Bid and Offer (NBBO) observed at a predefined short interval (e.g., 1, 5, or 15 minutes) after the trade. This post-trade midpoint aims to represent the security's fundamental value after any temporary price distortion caused by the¹²³⁴⁵