Informed Trading Premium

The informed trading premium is the additional cost or price adjustment that market makers incorporate to account for the risk of trading against informed participants. Because informed traders have a higher probability of moving the market in their favor, liquidity providers demand a premium to compensate for the resulting losses.

This premium is often embedded within the bid-ask spread or reflected in the pricing of options, such as the volatility skew. In efficient markets, this premium is a standard cost of doing business, but in opaque or manipulated markets, it can become excessive.

Recognizing this premium allows sophisticated traders to better estimate the true cost of execution and the level of market efficiency. It essentially quantifies the price of the information gap.