Fees and commissions

When a trade is carried out, a fee may be payable to a broker, or a spread may be
paid relative to the mid-market price of the security or contract in question. Typically,
in a market making operation, fees will be received, and spreads will result in a
profit. For a proprietary trading desk, in contrast, fees would usually be paid, and
spreads would be a cost. In some cases, fees and commissions are explicitly stated
on trade tickets. This makes it possible to separate them from other sources of profit
or loss. Spreads, however, are more difficult to deal with. If an instrument is bought
at a spread over the mid-price, this is not generally obvious. The price paid and the
time of the trade are recorded, but the current mid-price at the time of the trade is
not usually available. The P&L from the spread would become part of intraday P&L,
which would not impact clean P&L. To calculate the spread P&L separately, the midprice
would have to be recorded with the trade, or it would have to be calculated
afterwards from tick-by-tick security price data. Either option may be too onerous to
be practical.
Fluctuations in fee income relate to changes in the volume of trading, rather than
to changes in market prices. Market risk measures give no information about risk
from changes in fee income, therefore fees and commissions should be excluded
from P&L figures used for backtesting.