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If I'm entering into a Market order to buy (e.g., for a share of SPY), it's easy to see the spread that I am crossing: I can compare the "mid" average of the NBBO to the ask, and that's the spread I paid. So generally during trading hours, this would be \$0.005 for SPY (implying a $0.01 round-trip spread for SPY).

When I enter into MarketOnClose orders, however, it's not as obvious what spread (if any) I paid. All I think I see is the auction-clearing price at which all shares transact, and it's not clear what "ask" I should be comparing against.

Does this mean that, unlike pre-close Market orders, MarketOnClose orders don't cross a spread? Or is there a way to read or infer a bid/ask to calculate a spread?

Context

In several backtests, Overnight Anomly seems to provide superior Sharpe ratios to buy-and-hold strategies. Digging deeper into these backtests, however, it appears that they rely on MarketOnOpen and MarketOnClose orders, which don't obviously charge the strategy the cost of crossing the bid/ask on a daily basis.

But if everyone were entering into overnight trades, the closing auction would be so imbalanced with Market buys that the price would have to rise to clear the auction. And unlike trades during the day (where we can see the NBBO), it's not clear to me that it's easy to measure this impact.

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A market on close order is usually an order that is reversed for the closing auction.

When such orders not designed by exchanges, brokers are emulating them. For instance, if an exchange does not provides this feature inside its matching engine, your broker can build a mechanism that will retain your order up to send it to the exchange just at the start of the closing fixing. In such a case: if your broker has an IT/network issue, your order will never reach the close. Keep in mind that some exchanges do not have auction calls for the fixing (India for instance).

Market on close are usually market orders: whatever the price at the close they will accept it because implicitly they assume you want liquidity, not a good price. Nevertheless some exchanges accept limit prices for market on close, to prevent you to have an awful price if the price really goes away during the closing auction. There is a lot of information about this in Market Microstructure in Practice (2nd Edition) L and Laruelle, section 2.1.1.

From the boo, here is the typical flow of orders arriving for the close during the pre-fixing (horizontal axe is in minutes, vertical axe in quantity): flow of orders arriving for the close

It is not the same as target close algos, that are all designed by brokers, and have the discretion to create child orders, sending some of them before the close and others at the close. Thus your price will be the average of all this child prices.

Similarly, you can try to obtain a price improvement by not trading everything at the close, but wait more (this is an implicit suggestion in your question). And you are right to try to understand what would have been your price at the close: it is good to have a benchmark, to compare your execution to.

In your question you mention that

If I'm entering into a Market order to buy (e.g., for a share of SPY), it's easy to see the spread that I am crossing: I can compare the "mid" average of the NBBO to the ask, and that's the spread I paid.

I am not sure that it is that easy even in continuous trading:

  • what if you would have wait to send your order (opportunity cost)?
  • what if you would have split your order in two smallest ones, waiting for new liquidity to come in the orderbook (liquidity cost)?

These questions is indeed the same for orders sent during the continuous and fixing sessions.

These questions imply that it is difficult to have a benchmark because once you interacted with other market participants (via the orderbook), you changed their reaction and "what if I would have done something else?" scenarios are very difficult to assess.

Nevertheless there is no "bid-ask spread" during the prefixing, but they are two overlapping orderbooks: the one of the buy orders and the one of the sell orders. This is the imbalance between there two orderbooks that will form the price (in a Walrassian equilibrium manner). Hence after the close, you have the "next closest buying price" and the "next closest selling price" that you can use like bid and ask prices. Be careful that in most cases, not 100% of the offer or demand has been cleared at the close price, hence there is a signed remaining quantity, that you should take into account.

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A simpler way to debunk these studies without having actual trade and quote data at the exchange level is to just take into account transaction costs, IBKR's half a penny per share is a good starting point as mentioned above.

However for most exchanges, market on open/close orders execute as close to the open/close price as possible, not at the exact open/close price! You are correct to assume order imbalances and liquidity will have an impact.

These two factors are often omitted in academic studies as exchange level trade & quote data is quite large and expensive to do this study correctly.

As suggested by @nbbo2 I've added the SPY vs the NSPY (overnight only) total returns as a comparison.

SPY vs NSPY (overnight)

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    $\begingroup$ As an anecdote the new ETF called NSPY that tries to capture the Overnight Anomaly has not done well in the first month or two of operation. Transaction costs are a likely reason IMO. $\endgroup$
    – nbbo2
    Aug 30, 2022 at 16:59
  • $\begingroup$ Interestingly, Quantpedia's backtesting (via Quantconnect) seems to have standardized on a broker fee of $0.005/share up to a max of 0.5% of volume, but doesn't add anything in for impact during the auction. So they're missing some piece of factor 2 you mention. $\endgroup$
    – MikeRand
    Aug 30, 2022 at 20:09

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