IS 356 IT for Financial Services The Market for the Next 100 Years! pptallon/is356.htm

IS 356IT for Financial Services

The Market for the Next 100 Years!

http://www.evergreen.loyola.edu/~pptallon/is356.htm

April 19, 2023© Paul Tallon 2/28

April 19, 2023© Paul Tallon 3 / 32

Outline

How is NASDAQ different from NYSE? Technology

SelectNet SOES (small order execution system)

SuperSOES Understanding order flow: some tricks of the trade

SuperMontage Existing market shortcomings


Competing Business Models

NASDAQ(+ Island/Instinet)

Spear, Leeds & Kellogg (ECN)

Terra Nova Trading, LLC

B-Trade Services LLC

The Brass Utility, LLC*

Strike Technologies LLC*

Attain-ECN

PIM Global Equities – ECNDirect EdgeBATs

Liquidity ProvidersNone One Many

Merger w/ AMEX 11/98(later AMEX spun off)

NYSE(+ Archipelago ECN)

+AMEX (2008)


Auction Market Model

Floor-based Single Specialist Order-driven Capital commitment

limited to one firm Trade halts for volume

imbalances


Dealer Market Model

Screen-based Competing Market

Makers Quote-driven Capital commitment

from multiple firms


Screen-based Markets

Allow equal access to trading and market information (in theory)

World’s most common market structure Unlimited number of market

participants, so it facilitates expansion No central trading floor

− The network is the market – attack the network and the market will suffer


NASDAQ Level II Screen


Retail “Buy” Order

ASK

25.25

25.28

25.29

25.31

25.50

Retail “Buy”

MM

BID

25.00

24.87

24.86

24.85

24.84

200

Market Maker has 200 shares in

inventory.

Retail investor wants to “Buy” 200 shares @

25.25

MM

MM

AA

AACC

CC

DD

BB

BB

DD


Execution – Scenario 1

Retail “Buy”

MM

BID

25.00

24.87

24.86

24.85

24.84

200

Trade Report: 200 @ 25.25Trade Report: 200 @ 25.25

ASK

25.25

25.28

25.29

25.31

25.50

Market Maker fills “Buy” order at

best offer price of 25.25.


25.25.

“Sell”


Retail “Buy” Order – Scenario 2

Retail “Buy” MM

BID

25.00

24.87

24.86

24.85

24.84

“Sell”


Market Maker does not have shares in inventory. Market Maker sells short 200

shares at 25.25.

ASK

25.25

25.28

25.29

25.31

25.50


25.25.


Cover Short Position – Scenario 2

ASK

25.25

25.26

25.27

25.28

25.50

Retail “Buy”

MM

BID

25.12

25.00

24.87

24.85

24.84

Market Maker raises its “Bid” price to build inventory which affects other prices.

Retail “Sell”

200

Retail investor wants to “Sell” 200 shares.


Execution – Scenario 2ASK

25.25

25.26

25.27

25.28

25.50

MM

BID

25.12

25.00

24.87

24.85

24.84

Market Maker “Buys” 200 shares at its best bid price of 25.12


Retail “Sell”

200

Retail investor “Sells” 200 shares to Market Maker.

“Buy” 200

shares


BID

75.25

75.24

75.20

75.19

75.18

Preferencing Explained

ASK

75.30

75.31

75.32

75.35

75.39

Retail “Buy”

MM

Best bid in the market at this point is $75.25 so broker must sell at this price and no worse.

Retail “Sell”

1000

Broker receives order to sell 1000 CSCO at best market price. He asks MM to buy them.

Broker

CSCO

Preferred arrangement75.20 – 75.35

GLDM

LEGG

MM

MM

GLDM

LEGG

SCHB

SCHB

MM buys at $75.25 and kicks back to broker $0.005 per share or $5. (1M shares daily = $1.2M yr)

you buy from me at this price

I buy from you at this price


BID

75.25

75.24

75.20

75.19

75.18

Preferencing Explained.. cont’d

ASK

75.30

75.31

75.32

75.35

75.39

Retail “Buy”

MM

Best offer in the market at this point is $75.30 so market maker must sell at this price and no worse.

Brokers

Buy 2 x 500 from MM

Broker

CSCO

Bought 1000 at $75.25 even though bid $75.20

GLDM

LEGG

MM

MM

GLDM

LEGG

SCHB

SCHB

MM sells at $75.30 and kicks back to brokers $0.005 per share or $5. (1M shares daily = $1.2M)

Sales $75300Purchases $75250Kickback $5 + 2x$2.50Profit $40 per tradePer day 1m $40,000Annually $9.6m


NASDAQ Technology - SelectNet Order delivery and negotiation system (large orders usually) A communications tools between market makers and brokers System does not cross or execute orders SelectNet orders received at posted bids or offers must be

executed at that price Can be used to preference an order to a specific market maker

or to broadcast the order to the entire market − preference: a way to gain order flow without having to post the best

bid-offer (possible payment for order flow) Some large traders (e.g., mutual funds) can directly send an

order to the market through their broker – “pass-through”


NASDAQ Technology - SOES Electronic system for routing small orders from brokers to market

makers Automated system – if a market maker’s quote is hit, they cannot

back out of the trade Originally capped at 1,000 shares maximum Problems from day traders

– SelectNet trade followed rapidly by SOES order– Creates dual liability: “SOES bandits”

NASDAQ dropped limit – at market maker’s discretion Day traders moved to SelectNet instead – developed very fast order

execution interface: installed an automatic “back-away” complaint procedure, forcing market makers to comply.

(small order execution system)


NASDAQ Technology - SuperSOES Automated execution up to 9,900 shares 5 second delay between orders received from same broker Difficult for market maker to back away from a trade ECNs were included in the montage (or display of available

market makers) for each share but were liable to be cut off if their response to a trade request was deemed “slow”

Went live late 2001 Set the stage for SuperMontage


Comparisons (NASDAQ vs. SuperMontage)

Quotes on one screen;Orders on another

Everything on one screen


SuperMontage - features Shows depth of market on buy and sell side Enter multiple quotes/orders at the same time for a stock Ability to hold stock in reserve – don’t show the entire

order to the market at any one time. To avail of this, you must show a minimum order size of 1,000

Anonymity is possible – market maker’s name is masked Broker could previously cancel an order within 10 seconds

of submission (even if it was accepted by a market maker) – that is now removed so execution is automatic (ECNs can still refuse an order)


SuperMontage PowerView Screen

QuoteView

DepthView

(size is in 100’s)


Higher Fill Rates

93% of marketable orders are fully or partially executed, up from 67% pre-SuperMontage

A marketable order is a limit or market order that is executable at the time the order enters the system


Faster Execution Rates

Execution speed improve by almost 90%


Greater Depth and Use of Reserve

During the pre-launch period, approx. $125,000 was available 5 cents from the inside price on both the bid (buy) and ask (sell) side in Starbucks. About $95,000 of that was displayed.

This increased to $190,000 in the post-launch period. About $95,000 of that was displayed also.


Other Technology: Heat MapsOther Technology: Heat Maps

After-hours quotes…


Opening Prices – still some concerns

No consolidated order book for all market makers Opening prices are set between 8:00am and 9:30am Problem came to a head with dot.com IPOs Possibility of wide range of quotes at market open,

trades executed at inappropriate prices – not at the inside bid or ask

April 19, 2023

Intra-day Volatility (NYSE)

October - December 1999

0.00%

0.40%

0.80%

1.20%

1.60%

Hal

f-Hou

r V

olat

ility

The First 1/2 Hour

Source: Robert Schwartz, Baruch College, 2008

© Paul Tallon 27 / 32

April 19, 2023

October - December 2000

0.00%

0.50%

1.00%

1.50%

2.00%

Ha

lf-H

ou

r V

ola

tili

ty

The First 1/2 Hour

Intra-day Volatility (NASDAQ)



April 19, 2023

January - May 2000

0

0.5

1

1.5

2

2.5

3

8:00

-8:3

0

8:30

-9:0

0

9:00

-9:3

0

9:30

-10:

00

10:0

0-10

:30

10:3

0-11

:00

11:0

0-11

:30

11:3

0-12

:00

12:0

0-12

:30

12:3

0-1:

00

1:00

-1:3

0

1:30

-2:0

0

2:00

-2:3

0

20:3

0-3:

00

3:00

-3:3

0

3:30

-4:0

0

4:00

-4:3

0

Ha

lf-H

ou

r V

ola

tili

ty

The First 1/2 Hour

Intra-day Volatility (London)



April 19, 2023

January - May 2000

0

0.2

0.4

0.6

0.8

1

1.2

1.4

9:00-9

:30

9:30-1

0:00

10:00

-10:30

10:30

-11:00

11:00

-11:30

11:30

-12:00

12:00

-12:30

12:30

-1:00

1:00-1

:30

1:30-2

:00

2:00-2

:30

2:30-3

:00

3:00-3

:30

3:30-4

:00

4:00-4

:30

4:30-5

:00

Clos

ing Call

Ha

lf-H

ou

r V

ola

tili

ty

The First 1/2 Hour

Intra-day Volatility (Euronext)




Current Issues NASDAQ merged with Island/Instinet (ECN): April 22, 2005 Countered merger between NYSE and Arca|Ex: April 20, 2005 Fight between NYSE and NASDAQ goes international

NYSE EuroNext NASDAQ OM … interest from Dubai, Deutsche Bourse, etc.

Evolution of hybrid markets


For Next Class… Read

– ECNs – check out http://en.wikipedia.org/wiki/Electronic_Communication_Network

– Articles on class website

Documents

IS 356 IT for Financial Services The Market for the Next 100 Years! pptallon/is356.htm