Case 028Execution and market microstructureWarm up

The offers are 5,000 shares at 100.10, 8,000 at 100.20 and 12,000 at 100.35 around a mid of 100.00. You must buy 20,000 shares now. What is your average price and your impact against mid?

MizuhoHong Kong · 2024

The situation

Kirtika Securities must buy 20,000 shares of an invented mid-cap for a client, immediately, with a marketable order. The visible offers are 5,000 shares at Rs 100.10, 8,000 at Rs 100.20 and 12,000 at Rs 100.35. The best bid is Rs 99.90, so the mid is Rs 100.00.

The client measures execution against the mid at the moment the order arrived.

Your task

Compute the average price, the cost against mid in basis points and in rupees, and say what the order book tells you about how to do it better next time.

Quick check

Roughly what average price does the 20,000-share sweep pay?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The average price is Rs 100.2275, about 23 basis points over mid, or Rs 4,550 on the order. The order takes all 5,000 at 100.10, all 8,000 at 100.20 and 7,000 of the 12,000 at 100.35. The first 10 basis points is the half spread any buyer pays; the rest is impact from sweeping deeper levels, which is the part a patient or split execution can reduce.

Step 1What does sweeping the book actually pay?

Picture a vegetable market at closing time with three stalls selling tomatoes at rising prices. If you need 20 kg and the cheapest stall has 5, you buy its 5, then the next stall's 8, then 7 of the third stall's 12. A marketable order does exactly that: it pays each level's price for the shares at that level, in turn, until it is filled. The average price is the size-weighted mix of the levels consumed, not the best offer and not the last.

Buying 20,000 now walks up three price levels100.00100.10100.20100.30100.4005,00013,00020,00025,000Cumulative shares available on the offer5,000at 100.108,000at 100.207,000 of 12,000at 100.35mid 100.00average 100.227522.8 bps over midorder ends here
Buying 20,000 shares at once takes all 5,000 at 100.10, all 8,000 at 100.20 and 7,000 of the 12,000 at 100.35, for an average of 100.2275, about 23 basis points above the 100.00 mid.
LevelShares takenPrice, RsCost, RsOver mid, bps
Offer 15,000100.10500,50010
Offer 28,000100.20801,60020
Offer 37,000100.35702,45035
Total20,000100.22752,004,55022.75
The 20,000 shares cost Rs 2,004,550, an average of Rs 100.2275, against Rs 2,000,000 at mid: Rs 4,550 of cost, 22.75 basis points.
Step 2Which part of the cost could you have avoided?

Split the 22.8 basis points into two pieces. The first 10 is the half spread: any buyer who crosses to the offer pays it, even for one share. The other 12.8 basis points is impact, the price of wanting more than the best level holds, and it grows with size. The last 7,000 shares paid 35 basis points over mid, three and a half times the first 5,000. If the client could wait, splitting the order across a few minutes lets new sellers refill the 100.10 level between slices.

Then say what the visible book leaves out, because that is the real content of the liquidityHow much you can trade, how fast, and at what cost. Visible depth is one part; hidden orders and how quickly the book refills are the others. question. The screen shows only displayed size; there may be hidden orders inside the levels, and there may be sellers who pull their offers the moment a large buyer appears. Impact is therefore a range: the 100.23 average is what the displayed book promises, and it can be better if hidden size fills part of the order or worse if the 100.35 offers vanish. Check how the book has refilled after past sweeps of similar size before promising the client a number.

One more limit: after the sweep the best offer sits at 100.35 with 5,000 shares left, and other traders see a buyer has been through. The next slice, if there is one, will likely cost more than the first. That is why desks measure impact both at the fill and a few minutes later.

Where candidates lose it

The common loss is quoting the best offer, 100.10, or the worst level touched, 100.35, as the price paid. The first understates the cost by more than half; the second overstates it. The order pays a weighted average.

The second is forgetting that only 7,000 of the 12,000 at 100.35 are needed. Weighting the last level by its full displayed size gives an average of about 100.25 and a cost that is 2 basis points too high.

What the interviewer asks next

  • The client can wait ten minutes. How would you split the order, and what do you risk?
  • How would you estimate the cost if the book showed only the best level?
  • The spread doubles in the afternoon. What happens to the half-spread and the impact pieces?

Asked at Mizuho, Sales and Trading, Hong Kong, 2024 (Wall Street Oasis): Factors that you consider when analyzing liquidity and order book

Company names and figures are illustrative.