Paying the spread to sleep at night

Question

It's 2{:}30pm and you're long 8{,}000 shares, with the close at 4{:}00pm. The stock's overnight gap has a standard deviation of \1.20 per share. The market is 6 cents wide, so crossing the spread to dump your position costs 3 cents per share against the mid. Compare the cost of flattening now versus holding overnight. What should you do?

Accepted Answer

Cost of flattening by crossing the spread. To sell 8{,}000 shares by hitting the bid, you pay half the spread (3 cents) per share versus mid: 0.03 	imes 8{,}000 = \240. A certain, known cost of \240 to be flat. Cost (risk) of holding overnight. If you carry the 8{,}000 shares overnight, your position's gap risk is 	ext{one-sigma swing} = 8{,}000 	imes \1.20 = \9{,}600. That's a typical overnight move, a one-standard-deviation night. A two-sigma night would be about \19{,}200 in either direction. And this risk is uncompensated: you don't earn anything for holding the gap; you just expose yo…

Paying the spread to sleep at night

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