The Bid-Ask Spread: A Trading Charge With No Invoice

Two prices are quoted at the same moment because buying and selling are different transactions. The best buying price is what somebody will pay a seller now; the best selling price is what a buyer must pay now. The gap between them is the spread, a real charge on the trade that appears on no confirmation and is crossed once going in and once coming out.

Work the gap out on any quote

The six fields arrive already filled with the quote this guide works through, so a finished example is on the screen before anything is touched: a best buying price of Rs 100.00/- and a best selling price of Rs 100.20/-, a thousand units on offer at each, a trade of 1,000 units, and a reference price of Rs 100.10/-. The subtraction gives a spread of Rs 0.20/- a unit. Struck on the buying side that is 0.20 per cent, and therefore 20.00 basis pointsA hundredth of one per cent, so a hundred of them make one per cent. It is used wherever small rate differences would otherwise be written with a string of zeroes after the decimal point. of it. A trade of 1,000 units is an order value of Rs 1,00,000.00/- at the best buying price, the buying leg costs Rs 100.00/- against the reference and the selling leg costs Rs 100.00/-, and the round trip is Rs 200.00/-. Buying 1,000 units at Rs 100.20/- takes Rs 1,00,200.00/- out and selling them straight back at Rs 100.00/- brings Rs 1,00,000.00/- in. The difference is the same Rs 200.00/- reached the long way.

Move the reference price first, and watch what refuses to move with it. Set it to the best selling price and the buying leg goes level at Rs 0.00/- while the selling leg takes the whole Rs 200.00/-. Set it to the best buying price and the two swap over. Set it ten paise above the best selling price, at Rs 100.30/-, and the buying leg turns into Rs 100.00/- of gain while the selling leg becomes Rs 300.00/- of cost. The round trip is the spread multiplied by the trade size, and the reference price appears nowhere in that product, so it holds at Rs 200.00/- through every one of those. All the reference decides is where the cost gets booked, never how much of it there is, and the strip under the drawing shows the two legs adding to the total at every setting.

The two price fields move the gap itself, and two of the buttons walk it to either end. Narrow it to a single paisa and the midpoint computes to Rs 100.005/-, a figure no price could be printed at. The round trip on the same size falls to Rs 10.00/-. Widen it to eighty paise and those same 1,000 units read 80.00 basis points wide and a round trip of Rs 800.00/-. Rs 100.01/- and Rs 100.80/- both read as about a hundred rupees, so between those two settings the printed prices barely appear to move. The cost of the round trip moves by a factor of eighty.

Two of the six fields do something unexpected. The quantity standing beside each price is not decoration. Ask for five times what is on offer and the instrument computes Rs 1,000.00/- on 5,000 units, and the strip below turns red and says that only 1,000 of them are on offer at both best prices. Rs 200.00/- of that figure is priced by the keyed-in quote and the other 4,000 units are priced by nothing on this screen. The instrument has walked straight into the assumption every spread calculation quietly makes: the whole of the trade size deals at the best price on its side. Where the rest of a large order actually deals is a question about how a book fills, and it is not opened here.

Why are two prices quoted at the same moment rather than one?

Anybody willing to deal this second, in whichever direction the client turns up wanting, is taking on something and has to be paid for it. There is exactly one place that payment can sit if no bill is going to be sent, and that place is the two prices themselves. So the spread is not a flaw in the price or a sign that something is working badly. The spread is the price of being able to deal now, and it is charged by making the two quoted prices different rather than by adding a line to a document.

Consider the shop just outside a railway station that both buys and sells second-hand handsets. The same model sits in the window at Rs 8,000/-, and a customer walking in with one will be handed Rs 6,000/- for it. Both figures are true at the same instant, about the same object, at the same counter. Nobody is confused and nobody is cheating anybody. There are simply two transactions available, and they are priced separately because they are not the same transaction seen from two sides.

A quoted security works the same way and the vocabulary is the only thing that changes. The best buying price is the most that anybody, at this second, will hand over to take one unit off a holder. The best selling price is the least that anybody, at this second, will part with one unit for. At any instant there is no single price, there are two, and every single price reported anywhere was somebody's choice about which of the two to report or how to combine them. Almost every habit people have about prices was formed without that fact.

The money changer's board at an airport makes the point in public. Two columns, one headed with what the counter pays and one with what the counter charges, and the same currency on both rows with different figures beside it. Nobody looking at that board thinks there is one exchange rate being displayed twice. On a trading venue the two columns are still there; they are just not always printed side by side where both can be seen at once.

What is the spread, in rupees and as a rate on which base?

Start with the subtraction, the only step nobody argues about. Rs 100.20/- less Rs 100.00/- is Rs 0.20/-, and that is the spread in rupees on one unit. Then divide it by something to turn it into a rate, and the something is where every reader who gets into trouble gets into trouble. Set the twenty paise against Rs 100.00/-, the price on the buying side, and out comes 0.20 per cent struck on that and nothing else. The same Rs 0.20/- against a different price is a different percentage, so the base travels with the number or the number means nothing.

The calculator above reads the spread against the best buying price and names that base in the same sentence every time it prints the rate. Reading it against the buying side is a stated convention rather than a law of nature. Rs 100.20/- is the other price standing at that same instant, and putting the identical Rs 0.20/- over that instead gives 0.1996 per cent for the very same twenty paise. Neither reading is wrong. The error is printing one of them without saying which price sat underneath, and then comparing it with somebody else's figure that was struck on the other one.

The midpoint sits halfway between the two: can anybody deal there?

Rs 100.00/- and Rs 100.20/- added and halved give Rs 100.10/-. Half the spread is Rs 0.10/-. Both figures are useful for describing where a price roughly is, and both are used constantly for exactly that purpose. Nobody deals at the midpoint. Nobody has offered to. The lowest price anybody will accept is Rs 100.20/- and the highest price anybody will pay is Rs 100.00/-, and Rs 100.10/- sits in a space where no offer exists at all.

Watch what happens to the midpoint at a very narrow quote. The narrow case makes the point sharper than any argument. Set the best selling price at Rs 100.05/- and the midpoint becomes Rs 100.025/-, not even a whole number of paise. Rs 100.025/- is a perfectly good arithmetic answer and it could not be printed as a price at all. A figure that can land between two amounts anybody could actually transact in is not a price; it is a description of one. Whether a price is permitted to sit at such a figure at all, and how small a step a quoted price may move in, are both SEBI's to settle at sebi.gov.in, and neither answer appears above.

What does the whole spread come to on an order of Rs 1,00,000/-?

Fix the order first, so the arithmetic has something to stand on. An order valueThe rupee size of an instruction to buy or sell, before any charge is worked out on it. Here it is fixed at Rs 1,00,000/- and measured at the best buying price. of Rs 1,00,000/- measured at the best buying price of Rs 100.00/- is 1,000 units. The rate then applies: 0.20 per cent of Rs 1,00,000/- is Rs 200.00/-. Rs 200.00/- is the whole spread across the order, and the same figure comes out the long way, by multiplying 1,000 units by the Rs 0.20/- gap on each one.

Move the gap and watch what the same multiplication does. At a spread of Rs 0.05/-, or 0.05 per cent struck on the buying side, the same order carries Rs 50.00/-. At Rs 0.80/-, a rate of 0.80 per cent, it carries Rs 800.00/-. The amount is proportional to the order and to the spread and to nothing else at all. A gap that reads as small change on one unit can therefore be the largest single item on a large order. Notice the scale of that movement. Rs 100.05/- and Rs 100.80/- both read as about a hundred rupees, so from Rs 0.05/- to Rs 0.80/- the printed price barely seems to change while the amount on the order moves by a factor of sixteen.

Why is the spread met on the way in and again on the way out?

The crossing on the way out is the half that gets missed, and the wrong version of it is very common, so it is worth doing slowly. A purchase goes through at the best selling price and a sale would have to go through at the best buying price. Two doors, and the same one cannot be used twice. So the instant a purchase is done, the positionWhat is left held once a purchase has gone through, from that moment until it is sold. What it is worth, and what borrowing against it involves, are both covered separately. could only be turned back into money at a lower figure than the one paid.

Now the arithmetic, by two routes that must agree. Measure from the midpoint of Rs 100.10/-. Buying at Rs 100.20/- is Rs 0.10/- a unit above it, or Rs 100.00/- on 1,000 units, and selling at Rs 100.00/- is Rs 0.10/- a unit below it, another Rs 100.00/-. Two halves, Rs 200.00/- together. Measure instead from the price actually paid: 1,000 units cost Rs 1,00,200/- and selling them back brings in Rs 1,00,000/-, a difference of Rs 200.00/-. The gap is crossed twice and costs the whole of itself once. On this order that is Rs 200.00/- and not Rs 400.00/-. Reading it as the full Rs 200.00/- going in and the full Rs 200.00/- coming out counts the same crossing twice and doubles a real number into a wrong one.

The jeweller does this in the open at every wedding season and nobody thinks it strange. A shop will sell a chain at one rate and buy the same chain back at a lower one, and a customer who buys it in the morning and changes their mind by evening has paid the difference once. Not twice, and not a third time by walking in and out of the shop without transacting.

Who receives the spread, and why is there no line for it on any confirmation?

The spread goes to whoever was on the far side of the trade at that price, and that is where a reader meets something already familiar. A party that has stopped standing in the middle and taken the far side of the trade collects within the agreed figure, never alongside it. Nothing was added to the instruction; a price was quoted, the trade was done at it, and the payment was already sitting in the agreed figure.

Nothing was bolted on to the price. The gap is a feature of the price itself, and a feature leaves no amount for any line to carry. A confirmationThe paperwork a client receives once a trade has gone through, giving the quantity, the price dealt at, and each charge on a line of its own. Which of those lines has to be there is the authority named in the table below to decide. lists amounts that were levied, and an amount that was never levied cannot be listed. The missing line is not a gap in anybody's paperwork and it is not concealment. Being paid inside a price looks exactly like this from the client's side of the document, and once seen it is recognisable in every trade thereafter. How much a client has to be told about the price an order was filledExecuted, meaning matched against somebody prepared to stand on the other side of it. Whether each portion of an order gets its own price reported belongs to the authority named in the table below. at is a matter for SEBI at sebi.gov.in, and no answer to it appears anywhere above.

How does the spread sit beside the charges that do appear?

Put four items on the same order of Rs 1,00,000/- and read them off. The whole spread across a round trip is Rs 200.00/-. A charge cut as a proportion, at 0.10 per cent of the order value, is Rs 100.00/-. A charge cut as one fixed amount per order is Rs 20.00/-. And Kaveri Stock Exchange Limited, invented, takes a transaction fee struck at 0.00325 per cent of turnoverThe rupee value of what has changed hands over a stated period, which is the base a venue strikes its transaction fee on. It is a period figure and never a figure for one order. for the stated year, so a year of turnover at Rs 48,00,000 crore hands that venue Rs 156 crore of fee revenue, and the same rate on this single order is Rs 3.25/-.

Three things need saying before anybody ranks them. The two charge shapes are alternatives rather than a pair that gets added together: one arrangement takes a proportion of the order value and another takes a fixed amount per order, and the shapes are set beside each other rather than totted up into a bill. The spread is a percentage of a price, the charge is a percentage of an order value, and the venue's fee is a rate on a year of turnover being read here on a single order. The bases are all different, so each one is named in the same breath as its figure every time. And the Rs 100.00/- charge is struck once on this order while the Rs 200.00/- is the whole gap across a round trip. A strictly side-for-side reading therefore takes one half of the gap, Rs 100.00/-, and that lands on the same rupee as the charge for the arithmetic reason that half of 0.20 per cent is 0.10 per cent.

On the whole gap, the largest single item here is the one with no line on any document, and the smallest is the one whose rate anybody can look up. The ranking is an observation about these four settings and it stops there. All four figures are declared control settings, and a different set of settings would order them differently, so nothing follows about any arrangement, any venue or any charge sheet.

What is standing in the middle of a quoted price, and what goes without it?

Every part of this market has the same question put to it: who is standing in the middle, and what stops working if they step out. Put to a quoted price, the answer arrives quickly. Somebody has to be willing to be on the far side of a trade in either direction at any moment, whichever way the client turns up. Willingness to stand there is not free and it is not charity, and the two prices being different is exactly how it gets paid for.

Take that party away and see what falls over. The market does not fail and the ability to trade does not fail: the loss is the ability to deal at this instant. The order bookEvery instruction that has not yet found a match, queued at whatever price the person sending it picked. What sits in one, and the order it sits in, are covered separately. would still hold orders waiting at prices somebody picked, and one of them may agree with the instruction in a minute or a month. A person with a house to sell is in exactly that position: there is a market, there is no price to transact at right now, and the wait begins. Whether a gap is wide or narrow in the first place is a question about how prices form, covered separately.

How does somebody placing an order actually use this?

Who sets the conditions around a quoted price?

Four conditions named above are an authority's to decide, never a venue's and never a trader's, and any of the four can be revised without warning. A value typed for one of them would turn false the moment it is revised, rather than merely growing stale. The table below therefore leaves its middle column blank and puts the name of whoever decides the matter where the number would have gone. An empty sheet still teaches two things worth having: that the condition is there at all, and whose door to knock on about it.