Post on 07-Mar-2018
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Multiple MarketsChapter 5
Copyright 2017, Joel Hasbrouck, All rights reserved 1
Securities Trading: Principles and Procedures
Consolidated and fragmented markets
Consolidated: all trading happens in one place
▪ One trading floor or one computer system
▪ Example: Many US futures contracts trade only in the CME’s Globex limit order book.
Fragmented: trading is distributed across multiple systems.
▪ US equity markets have multiple trading centers and multiple limit order books
2Copyright 2017, Joel Hasbrouck, All rights reserved
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Trading and listing of US equities
The “home” for trading a stock is the stock’s primary listing exchange.
The primary listing exchange …
▪ Provides trading facilities/procedures.
▪ May arrange for a market maker to assist trading.
▪ Coordinates openings and trading halts
▪ But does not have a monopoly on trading.
Many places to trade; many different mechanisms.
3Copyright 2017, Joel Hasbrouck, All rights reserved
Trading volume for NYSE- and Nasdaq-listed shares, Thursday, September 3, 2015
Copyright 2017, Joel Hasbrouck, All rights reserved 4
Listing ExchangeNYSE Nasdaq
Executing exchange Volume (shares) Percent Volume (shares) PercentNew York 888,211,019 25.5%Chicago 32,179,766 0.9% 4,734,313 0.3%CBOENYSE Arca 268,314,314 7.7% 190,499,278 10.7%Nasdaq 483,244,025 13.9% 462,893,665 26.0%Finra/Nasdaq TRF 1,028,036,386 29.5% 618,930,619 34.7%PSX 34,570,784 1.0% 22,131,465 1.2%NYSE MKT 4,054,051 0.2%Boston 64,346,462 1.8% 36,566,140 2.1%National Exch.BATS 220,062,627 6.3% 123,326,549 6.9%BATS Y 141,654,672 4.1% 74,398,173 4.2%EdgeA 83,144,604 2.4% 43,220,696 2.4%EdgeX 244,826,872 7.0% 202,827,823 11.4%Composite (total) 3,488,591,531 100.0% 1,783,582,772 100.0%
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A partial key
CBOE: Chicago Board Options Exchange, which can also trade stocks
Finra/Nasdaq TRF (Trade Reporting Facility)
▪ Reporting channel for “dark” trades
PSX (Nasdaq-owned former Phildadelphia Stock Exchange)
BATS (“Best alternative trading system”)
5Copyright 2017, Joel Hasbrouck, All rights reserved
During regular trading hours (9:30am-4:00pm Eastern) …
batstrading.com and look at the live book for SPY.▪ This is the book at the “main” BATS exchange (BZX).
BATS actually runs four separate exchanges with their own limit order book (BZX, BZY, EDGX, and EDGA)▪ You can toggle between these books in the display.
BZX vs. BZY▪ Compare the SPY books▪ Compare the PRK books
How are BZX, BZY, EDGX, and EDGA different? Why would we send an order to one or another? ▪ Differences in rules and fees
Copyright 2017, Joel Hasbrouck, All rights reserved 6
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BZX and BYX
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Holding things together
Fragmentation has problems.▪ Buyers and sellers must search across markets.
To help, we have linking systems virtual consolidation.▪ The nodes in a fragmented market are linked so that the
fragmented market appears to the user as if it were consolidated.
The types of systems are:▪ Market information▪ Access▪ Routing
8Copyright 2017, Joel Hasbrouck, All rights reserved
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Market information systems: market users
▪ Transmit trade reports, bid and ask quotes.
▪ Consolidate information.
Access systems: users market
▪ “Access” a bid/ask: execute (hit the bid or lift the offer).
▪ Must have verification and security.
Routing systems forward orders to other markets, other brokers.
Copyright 2017, Joel Hasbrouck, All rights reserved 9
Routing example
Routing decision
▪ I have an order. Where should I send it …based on market conditions, relationships, legal obligations, and so on.
A customer enters an order with their broker (E*TRADE): “buy 100 MSFT at the market.”
▪ E*TRADE might send it to Citigroup Capital Markets.
▪ … which might execute the order or send it to NASDAQ
▪ … which might execute the order or send it to ???
Copyright 2017, Joel Hasbrouck, All rights reserved 10
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The National Best Bid and Offer (NBBO)
All quoting market centers communicate their bids and offers to a consolidation system.
The highest bid is the National Best Bid; the lowest offer is the National Best Offer.
The NBBO are reference prices for retail orders and dark trades.
The midpoint of the NBBO is a benchmark to measuring trading costs.
Copyright 2017, Joel Hasbrouck, All rights reserved 11
Determination of the NBB
Market centers update their bids and ask frequently.
The Consolidated Tape Association (CTA) collects everything …
▪ And maintains a list of what every center is currently bidding.
▪ The NBB is the max price in this list.
The CTA transmits the NBB to users.
Next: example
Copyright 2017, Joel Hasbrouck, All rights reserved 12
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The quote data stream Calculation of the NBBTime Exchange Bid Offer A B C NBB AtBBid9:31 A 10.01 10.04 10.01 10.01 A9:32 B 10.03 10.07 10.01 10.03 10.03 B9:33 C 10.00 10.04 10.01 10.03 10.00 10.03 B9:34 A 10.02 10.03 10.02 10.03 10.00 10.03 B9:35 A 10.01 10.07 10.01 10.03 10.00 10.03 B9:36 B 10.00 10.04 10.01 10.00 10.00 10.01 A9:37 C 10.01 10.09 10.01 10.00 10.01 10.01 AC9:38 B 10.01 10.06 10.01 10.01 10.01 10.01 ABC9:39 B 10.01 10.05 10.01 10.01 10.01 10.01 ABC9:40 C 10.04 10.08 10.01 10.01 10.04 10.04 C9:41 B 10.03 10.07 10.01 10.03 10.04 10.04 C9:42 A 10.04 10.05 10.04 10.03 10.04 10.04 AC9:43 C 10.01 10.03 10.04 10.03 10.01 10.04 A9:44 A 10.05 10.07 10.05 10.03 10.01 10.05 A9:45 C 10.06 10.10 10.05 10.03 10.06 10.06 C9:46 A 10.06 10.12 10.06 10.03 10.06 10.06 AC9:47 B 10.04 10.11 10.06 10.04 10.06 10.06 AC9:48 B 10.06 10.09 10.06 10.06 10.06 10.06 ABC
Time Ex Bid Offer A B C NBO AtBOfr9:31 A 10.01 10.04 10.04 10.04 A9:32 B 10.03 10.07 10.04 10.07 10.04 A9:33 C 10.00 10.04 10.04 10.07 10.04 10.04 AC9:34 A 10.02 10.03 10.03 10.07 10.04 10.03 A9:35 A 10.01 10.07 10.07 10.07 10.04 10.04 C9:36 B 10.00 10.04 10.07 10.04 10.04 10.04 BC9:37 C 10.01 10.09 10.07 10.04 10.09 10.04 B9:38 B 10.01 10.06 10.07 10.06 10.09 10.06 B9:39 B 10.01 10.05 10.07 10.05 10.09 10.05 B9:40 C 10.04 10.08 10.07 10.05 10.08 10.05 B9:41 B 10.03 10.07 10.07 10.07 10.08 10.07 AB9:42 A 10.04 10.05 10.05 10.07 10.08 10.05 A9:43 C 10.01 10.03 10.05 10.07 10.03 10.03 C9:44 A 10.05 10.07 10.07 10.07 10.03 10.03 C9:45 C 10.06 10.10 10.07 10.07 10.10 10.07 AB9:46 A 10.06 10.12 10.12 10.07 10.10 10.07 B9:47 B 10.04 10.11 10.12 10.11 10.10 10.10 C9:48 B 10.06 10.09 10.12 10.09 10.10 10.09 B
Calculation of the NBO
Same process, only we use the min across exchanges.
Next overhead: putting it all together; the NBBO spread.
14Copyright 2017, Joel Hasbrouck, All rights reserved
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Bids OffersTime Ex Bid Offer A B C NBB AtBBid A B C NBO AtBOfr Spread9:31 A 10.01 10.04 10.01 10.01 A 10.04 10.04 A 0.039:32 B 10.03 10.07 10.01 10.03 10.03 B 10.04 10.07 10.04 A 0.019:33 C 10.00 10.04 10.01 10.03 10.00 10.03 B 10.04 10.07 10.04 10.04 AC 0.019:34 A 10.02 10.03 10.02 10.03 10.00 10.03 B 10.03 10.07 10.04 10.03 A 0.00Locked9:35 A 10.01 10.07 10.01 10.03 10.00 10.03 B 10.07 10.07 10.04 10.04 C 0.019:36 B 10.00 10.04 10.01 10.00 10.00 10.01 A 10.07 10.04 10.04 10.04 BC 0.039:37 C 10.01 10.09 10.01 10.00 10.01 10.01 AC 10.07 10.04 10.09 10.04 B 0.039:38 B 10.01 10.06 10.01 10.01 10.01 10.01 ABC 10.07 10.06 10.09 10.06 B 0.059:39 B 10.01 10.05 10.01 10.01 10.01 10.01 ABC 10.07 10.05 10.09 10.05 B 0.049:40 C 10.04 10.08 10.01 10.01 10.04 10.04 C 10.07 10.05 10.08 10.05 B 0.019:41 B 10.03 10.07 10.01 10.03 10.04 10.04 C 10.07 10.07 10.08 10.07 AB 0.039:42 A 10.04 10.05 10.04 10.03 10.04 10.04 AC 10.05 10.07 10.08 10.05 A 0.019:43 C 10.01 10.03 10.04 10.03 10.01 10.04 A 10.05 10.07 10.03 10.03 C -0.01Crossed9:44 A 10.05 10.07 10.05 10.03 10.01 10.05 A 10.07 10.07 10.03 10.03 C -0.02Crossed9:45 C 10.06 10.10 10.05 10.03 10.06 10.06 C 10.07 10.07 10.10 10.07 AB 0.019:46 A 10.06 10.12 10.06 10.03 10.06 10.06 AC 10.12 10.07 10.10 10.07 B 0.019:47 B 10.04 10.11 10.06 10.04 10.06 10.06 AC 10.12 10.11 10.10 10.10 C 0.049:48 B 10.06 10.09 10.06 10.06 10.06 10.06 ABC 10.12 10.09 10.10 10.09 B 0.03
NBBO notes
Might have different exchanges at the NBB and the NBO.
NBBO spread = 𝑁𝐵𝑂 − 𝑁𝐵𝐵.
When 𝑠𝑝𝑟𝑒𝑎𝑑 = 0, the market is locked.
▪ A trade could occur.
When 𝑠𝑝𝑟𝑒𝑎𝑑 < 0, the market is crossed.
▪ There should be an arbitrage.
Locked and crossed markets only arise across different exchanges. Within any single exchange, locks and crosses don’t occur.
Next overhead: Embedded practice problem. Compute the NBBO and the spread. Answer is at the end of the handout.
Copyright 2017, Joel Hasbrouck, All rights reserved 16
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Bids Offers
Time Ex Bid Offer A B C NBB AtBBid A B C NBO AtBOfr Spread
11:03C 20.10 20.20
11:04A 20.09 20.18
11:05B 20.11 20.20
11:06B 20.10 20.11
11:07A 20.08 20.10
11:08B 20.07 20.09
11:09B 20.08 20.20
11:10A 20.03 20.12
11:11B 20.04 20.11
11:12C 20.04 20.18
11:13C 20.05 20.11
11:14A 20.06 20.11
11:15C 20.04 20.13
11:16B 20.03 20.10
11:17A 20.02 20.09
11:18C 20.07 20.11
11:19B 20.08 20.09
11:20B 20.02 20.08
Latencies and market systems
Most traders obtain data through consolidated feeds.
Many market centers allow users (“subscribers”) to obtain direct lines, which are faster.
18Copyright 2017, Joel Hasbrouck, All rights reserved
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NYSE trade execution (100 sh
SPY @ 70.11)
Consolidated Trade System
Bloomberg
User K
User J
Direct subscriber line
“The consolidated feed” Note: there is a parallel Consolidated Quote System (CQS)The CQS computes the “official” NBBO
NASDAQ trade execution (200 sh
SPY @ 71.12)
Direct subscriber line
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User J: “Buy 200 shSPY @ 80”
Nasdaq
Broker
Brokered access
Direct market access (DMA)
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Priority in a fragmented market
Within a single book, orders are usually prioritized by price, visibility, time.
When there are two orders on different books, any and all of these priorities may be violated.
21Copyright 2017, Joel Hasbrouck, All rights reserved
Trade-throughs
A trade-through is a violation of price priority
Suppose that in a floor market …
▪ Trader A bids 100,
▪ Trader B bids 99
▪ Trader C sells to B at 99
▪ “C traded though A’s bid.”
▪ The people who are hurt are A and C
or, if A and C are brokers, their customers
22Copyright 2017, Joel Hasbrouck, All rights reserved
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Why do we have trade-throughs?
Ignorance.
▪ C may not be aware of A’s bid.
Speed.
▪ C might be in a hurry.
Doubt.
▪ C might think that A’s bid isn’t real or won’t be honored.
23Copyright 2017, Joel Hasbrouck, All rights reserved
SEC Regulation NMS (“Reg NMS”)
NMS: National Market System
Adopted 2005
Governs the interaction of multiple US equity markets.
Provisions
▪ Order protection against trade-throughs
▪ Access fees
▪ Subpenny rule
▪ Market data rules
24Copyright 2017, Joel Hasbrouck, All rights reserved
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What does the order protection rule say?
“It is illegal to trade through protected orders.”
“Trade-throughs are prohibited.”
“Trade-throughs should never happen.”
Markets shall “establish, maintain, and enforce written policies and procedures reasonably designed to prevent” trade-throughs.
You have to try to avoid trade-throughs (but you might fail).
Copyright 2017, Joel Hasbrouck, All rights reserved 25
What orders (bids and offers) are protected?
Suppose in a floor market …
▪ Amy: “Bidding 100”
▪ Boris: “Bidding 101”
▪ Cathy: “Sold [to Boris, at 101]”
Amy: “You traded through me.”
Boris & Cathy: “?????”
Amy: “My customer’s limit price is 105. I would have bid up to 105.”
Boris & Cathy: “Well, you didn’t. How were we supposed to know?”
Not a trade-through.
OPR: An order must be visible (displayed) to be protected.
Copyright 2017, Joel Hasbrouck, All rights reserved 26
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Suppose in a floor market …
▪ Amy: “Bidding 48 for 2 [contracts].”
▪ Brian: “… 49 for 4.”
▪ Cathy: “… 50 for 3.”
▪ Dana: “Sell 3 to Cathy at 50; 2 to Amy at 48!”
▪ Brian:“Sell to Amy at 48!? I’m bidding 49!”
▪ Dana: “Sorry. I was paying attention to the best bid. I heard Cathy and Amy, but I didn’t hear you.”
OPR: An order must be at the top of the market to be protected. Bids below the highest [visible] bid and offers above the lowest [visible] offer aren’t protected.
Copyright 2017, Joel Hasbrouck, All rights reserved 27
To be protected, a bid or offer must be …
Visible
At the top of the market’s book.
▪ The orders limit price must be equal to the best visible bid or best visible offer.
Accessible (electronically, for immediate execution).
Copyright 2017, Joel Hasbrouck, All rights reserved 28
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What are “reasonable” procedures to avoid trade-throughs?
Before a market center executes an order, it must check the protected bids and offers.
If it appears that the execution would cause a trade-through, the market center must either
▪ Return the order unexecuted.
▪ Route the order or part of the order to a market where it could be executed without causing a trade-through.
Note: there is an alternative procedure, the intermarketsweep order (ISO), which will be discussed later.
Copyright 2017, Joel Hasbrouck, All rights reserved 29
Example 1: the bid books on markets A and B
30
What are the protected orders? A has an incoming order: Sell 1,000 limit 47. A thinks: If we execute the entire order against own book: 300 @ 50, 400 @48, 300 @ 47.
▪ This would trade through B’s protected bid of 49 for 100 shares. A’s revised plan: Send a 100 share sell order to B, execute the rest against our own book.
▪ 100 @ 49 on B, 300 @ 50 on A, 400 @48 on A, 200 @ 47 on A. This is okay.
Price Market A Market B
50 300 shares
49 100 shares
48 400 500
47 800
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Example 2: the bid books on markets A and B
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What are the protected orders?
A has an incoming order; Sell 1,000 limit 47.
A thinks: If we execute the entire order against own book: 300 @ 50, 400 @48, 300 @ 47.
▪ This would trade through B’s protected bid of 49 for 100 shares.
A’s revised plan: Send a 100 share sell order to B, execute the rest against our own book.
A expects: 100 @ 49 on B, 300 @ 50 on A, 400 @48 on A, 200 @ 47 on A.
What actually happens: 100 @ 50 on B, 300 @ 50 on A, 400 @48 on A, 200 @ 47 on A.
▪ This is okay, even though B’s protected 100 shares at 49 are traded through. A tried to avoid a trade-through, based on what was visible.
Price Market A Market B
50 300 shares 100 shares, HIDDEN
49 100
48 400 500
47 800
Answer to embedded problem
Steps
▪ For the NBB:
Enter the bid for the exchange that just updated.
Propagate the bids downwards for each exchange.
Take the max to get the NBB
▪ Repeat for the NBO, using the ask and the min
▪ Compute the spread
Copyright 2017, Joel Hasbrouck, All rights reserved 32
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BidsTime Ex Bid Offer A B C NBB AtBBid11:03C 20.10 20.20 20.1011:04A 20.09 20.18 20.0911:05B 20.11 20.20 20.1111:06B 20.10 20.11 20.1011:07A 20.08 20.10 20.08
BidsTime Ex Bid Offer A B C NBB AtBBid11:03C 20.10 20.20 20.1011:04A 20.09 20.18 20.09 20.1011:05B 20.11 20.20 20.09 20.11 20.1011:06B 20.10 20.11 20.09 20.10 20.1011:07A 20.08 20.10 20.08 20.10 20.10
BidsTime Ex Bid Offer A B C NBB AtBBid11:03C 20.10 20.20 20.10 20.10 C11:04A 20.09 20.18 20.09 20.10 20.10 C11:05B 20.11 20.20 20.09 20.11 20.10 20.11 B11:06B 20.10 20.11 20.09 20.10 20.10 20.10 BC11:07A 20.08 20.10 20.08 20.10 20.10 20.10 BC
Step 1. Copy the bid for the updating exchange.
Step 2. Propagate the bids that haven’t changed.
Step 3. Take the max; see who matches the max.
Bids OffersTime Ex Bid Offer A B C NBB AtBBid A B C NBO AtBOfr Spread11:03C 20.10 20.20 20.10 20.10 C 20.20 20.20 C 0.1011:04A 20.09 20.18 20.09 20.10 20.10 C 20.18 20.20 20.18 A 0.0811:05B 20.11 20.20 20.09 20.11 20.10 20.11 B 20.18 20.20 20.20 20.18 A 0.0711:06B 20.10 20.11 20.09 20.10 20.10 20.10 BC 20.18 20.11 20.20 20.11 B 0.0111:07A 20.08 20.10 20.08 20.10 20.10 20.10 BC 20.10 20.11 20.20 20.10 A 0.00Locked11:08B 20.07 20.09 20.08 20.07 20.10 20.10 C 20.10 20.09 20.20 20.09 B -0.01Crossed11:09B 20.08 20.20 20.08 20.08 20.10 20.10 C 20.10 20.20 20.20 20.10 A 0.00Locked11:10A 20.03 20.12 20.03 20.08 20.10 20.10 C 20.12 20.20 20.20 20.12 A 0.0211:11B 20.04 20.11 20.03 20.04 20.10 20.10 C 20.12 20.11 20.20 20.11 B 0.0111:12C 20.04 20.18 20.03 20.04 20.04 20.04 BC 20.12 20.11 20.18 20.11 B 0.0711:13C 20.05 20.11 20.03 20.04 20.05 20.05 C 20.12 20.11 20.11 20.11 BC 0.0611:14A 20.06 20.11 20.06 20.04 20.05 20.06 A 20.11 20.11 20.11 20.11 ABC 0.0511:15C 20.04 20.13 20.06 20.04 20.04 20.06 A 20.11 20.11 20.13 20.11 AB 0.0511:16B 20.03 20.10 20.06 20.03 20.04 20.06 A 20.11 20.10 20.13 20.10 B 0.0411:17A 20.02 20.09 20.02 20.03 20.04 20.04 C 20.09 20.10 20.13 20.09 A 0.0511:18C 20.07 20.11 20.02 20.03 20.07 20.07 C 20.09 20.10 20.11 20.09 A 0.0211:19B 20.08 20.09 20.02 20.08 20.07 20.08 B 20.09 20.09 20.11 20.09 AB 0.0111:20B 20.02 20.08 20.02 20.02 20.07 20.07 C 20.09 20.08 20.11 20.08 B 0.01