The spread tightness index is a quantitative measure that assesses the narrowness of the bid-ask spread across a financial instrument, indicating market liquidity and efficiency. In crypto investing, this index reflects the immediate cost of transacting a digital asset, where a lower value signifies a more liquid and efficient market for RFQ crypto and institutional options trading.
Mechanism
The index is calculated by normalizing the absolute bid-ask spread by the asset’s price, often expressed as a percentage or basis points. Advanced versions may incorporate order book depth to provide a liquidity-weighted spread. The mechanism involves real-time aggregation of bid and ask quotes from multiple venues, followed by computation and periodic updating of the index value.
Methodology
Monitoring the spread tightness index is crucial for smart trading algorithms and risk management systems. A tightening index suggests increased liquidity and reduced trading costs, potentially triggering more aggressive execution strategies. Conversely, a widening index signals decreasing liquidity, prompting adjustments to order sizing or timing to mitigate market impact. It directly informs pricing models in RFQ environments.
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