multiple markets chapter 5 - new york universitypeople.stern.nyu.edu/jhasbrou/teaching/post draft...

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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.


Trading volume for NYSE- and Nasdaq-listed shares, Thursday, September 3, 2015


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”)


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


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BZX and BYX


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


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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.


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 ???


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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.


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


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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.


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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.


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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.


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19

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.


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


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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.


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


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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).


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.


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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.


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).


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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.


Example 1: 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.

▪ 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


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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

multiple markets chapter 5 - new york universitypeople.stern.nyu.edu/jhasbrou/teaching/post draft...

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