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Quoting a market in the spread A minus B

Question

You make markets in two products, written bid @ ask: product AA is quoted 4 @ 54 \text{ @ } 5 and product BB is quoted 10 @ 1210 \text{ @ } 12. You are now asked to quote the combination A−BA - B (long one AA, short one BB), consistent with your existing markets.

If your market in A−BA-B is X @ YX \text{ @ } Y, report Y2−X2Y^2 - X^2.

Short answer

−39-39. To buy A−BA-B you would buy AA at your bid and sell BB at your ask, so the bid is 4−12=−84-12=-8; to sell it you sell AA at your ask and buy BB at your bid, so the ask is 5−10=−55-10=-5. The market is −8 @ −5-8 \text{ @ } -5 and 25−64=−3925-64=-39. Simply subtracting bid from bid would give a crossed market.

Adapted from QuantQuestions.io; question and answer rewritten by SelfMadeQuant.com.

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