Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public...
-
date post
19-Dec-2015 -
Category
Documents
-
view
220 -
download
2
Transcript of Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public...
![Page 1: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/1.jpg)
Chapter 3
How Securities Are Traded
![Page 2: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/2.jpg)
Topics Covered How securities are first marketed to the
public by investment bankers
Underwriters, IPOs – Underpricing, SEOs How and where already-issued securities
are traded among investors.
Mechanics of trading – specialist vs. dealer markets
Costs of trading – spreads, commissions, Nasdaq controversy on dealer collusion
Buying on margin and short selling
![Page 3: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/3.jpg)
Primary vs. secondary security sales
Primary• New issue• Key factor: issuer receives the proceeds from
the sale. Secondary
• Existing owner sells to another party.• Issuing firm doesn’t receive proceeds and is
not directly involved.
![Page 4: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/4.jpg)
![Page 5: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/5.jpg)
Primary markets: Public offerings
Public offerings: registered with the SEC and sale is made to the investing public.• Shelf registration (Rule 415, since 1982)
Initial Public Offerings (IPOs)• Evidence of underpricing• Performance
![Page 6: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/6.jpg)
Figure 3.3 Average Initial Returns for IPOs in Various Countries
![Page 7: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/7.jpg)
Figure 3.4 Long-term Relative Performance of Initial Public Offerings
![Page 8: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/8.jpg)
Investment Banking Arrangements Underwritten vs. Best Efforts
• Underwritten: firm commitment on proceeds to the issuing firm.
• Best Efforts: no firm commitment.
Negotiated vs. Competitive Bid
• Negotiated: issuing firm negotiates terms with investment banker.
• Competitive bid: issuer structures the offering and secures bids.
![Page 9: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/9.jpg)
Figure 3.1 Relationship Among a Firm Issuing Securities, the Underwriters and the Public
![Page 10: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/10.jpg)
US primary listing market
New York Stock Exchange (N) American Stock Exchange (A) NASDAQ (Q) Over-the-Counter (OTC)
• Nasdaq small cap (S)• OTCBB (U)• Pink Sheets
![Page 11: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/11.jpg)
Primary markets: Private placements
Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration.
Dominated by institutions. Very active market for debt securities. Not active for stock offerings.
![Page 12: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/12.jpg)
Organization of secondary markets
Organized exchanges OTC market Third market Fourth market
![Page 13: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/13.jpg)
Trading Mechanisms
Specialists markets (NYSE) Dealer markets (NASDAQ) Electronic communication networks
(ECNs)
![Page 14: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/14.jpg)
Organized Exchanges
Auction markets with centralized order flow.
Dealership function: can be competitive or assigned by the exchange (Specialists).
Securities: stock, futures contracts, options, and to a lesser extent, bonds.
Examples: NYSE, AMEX, Regionals, CBOE.
![Page 15: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/15.jpg)
NYSE The NYSE is a hybrid market. It has:
• floor traders (like a futures pit)• an electronic limit order book (like Euronext)• a designated dealer (the specialist) to maintain
liquidity and otherwise coordinate trading.
This mix is the outcome of political, technological and economic forces over the last 200 years.
![Page 16: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/16.jpg)
Table 3.2 Seat Prices on the NYSE
![Page 17: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/17.jpg)
NYSE NYSE’s MarkeTrac: http://marketrac.nyse.com/mt/
![Page 18: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/18.jpg)
![Page 19: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/19.jpg)
Nasdaq
National Market System Nasdaq SmallCap Market Levels of subscribers
• Level 1 – inside quotes• Level 2 – receives all quotes but they can’t enter
quotes• Level 3 – dealers making markets• SuperMontage
OTC Bulletin Board
![Page 20: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/20.jpg)
Table 3.1 Partial Requirements for Listing on Nasdaq Markets
![Page 21: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/21.jpg)
Table 3.3 Some Initial Listing Requirements for the NYSE
![Page 22: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/22.jpg)
![Page 23: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/23.jpg)
Trading of Exchange-Listed Securities
Investor Broker Commission Broker or Floor Broker on the exchange Specialists (Market Maker or Dealer)
Each stock is assigned to a specialist. The specialist usually handles several stocks
Trading of Nasdaq Securities
Investor Broker Dealers
More than 400 dealer firms
A stock is typically handled by 10 –20 dealer firms
![Page 24: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/24.jpg)
US regional exchanges
Pacific Exchange / Archipelago (P) Chicago (formerly Midwestern)
Stock Exchange (M) Boston Stock Exchange (B) Philadelphia Stock Exchange (X) Cincinnati Stock Exchange (C)
![Page 25: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/25.jpg)
Third markets
Trading of listed securities away from the exchange.
Institutional market: to facilitate trades of larger blocks of securities.
Involves services of dealers and brokers
![Page 26: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/26.jpg)
Fourth Market
Trading in exchange-listed stocks within Alternative Trading Systems (ATS), such as ECNs (Instinet, Island, Archipelago)
Institutions trading directly with institutions
No middleman involved in the transaction
![Page 27: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/27.jpg)
Table 3.5 Electronic Computer Networks (ECNs)
![Page 28: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/28.jpg)
Major international stock markets Europe
• London Stock Exchange (LSE)• EuroNext (Paris/Netherlands/Belgium)• Deutsche Borse (DB)• Milan Stock Exchange• Swiss Stock Exchange
Stockholm/Copenhagen/Helsinki/Oslo (OM)
Toronto Stock Exchange (TSX)
![Page 29: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/29.jpg)
Asia
• Tokyo Stock Exchange (TSE)• Taiwan Stock Exchange• Korean Stock Exchange (KSE)• Australian Stock Exchange (ASX)• Hong Kong Stock Exchange
![Page 30: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/30.jpg)
International market structures London Stock Exchange
• Dealer market similar to NASDAQ• Stock Exchange Automated Quotation • Greater Anonymity
Tokyo Stock Exchange• No market making service• Electronic limit order book• No longer uses Sai-tori or floor trader (since
1999)
![Page 31: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/31.jpg)
Figure 3.7 Dollar Volume of Trading in Major World Markets, 2004
![Page 32: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/32.jpg)
Costs of Trading
Commission: fee paid to broker for making the transaction
Spread: cost of trading with dealer• Bid: price dealer will buy from you• Ask: price dealer will sell to you• Spread: ask - bid
Combination: on some trades both are paid
![Page 33: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/33.jpg)
Orders and Order Properties
![Page 34: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/34.jpg)
Orders Orders are instructions to trade that
traders give to brokers and exchanges that arrange their trades.
Orders always specify• The security to be traded• The quantity to be traded• The side of the order (buy or sell)
![Page 35: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/35.jpg)
Orders may specify• Price specifications• How long the order is valid• When the order can be executed• Whether they can be partially filled or not
![Page 36: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/36.jpg)
Some important terms 1
Bid: buy order specifying a price (price is called the bid).
Offer: sell order specifying a price (price is called offer or ask).
Best Bid: standing buy order that bids the highest price bid.
Best offer: standing sell order that has the lowest price offer.
![Page 37: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/37.jpg)
Some important terms 2
Dealers have an obligation to continuously quote bids and offers, and the associated sizes (number of shares), when they are registered market markers for the stock.
Their quotes also have to be firm during regular market hours.
![Page 38: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/38.jpg)
Some important terms 3 Public orders with a price limit can also
become the market bid or offer if they are at a better price than those currently quoted by a registered market maker.
The market’s best bid and offer constitute the inside market, the best bid/ask, or the BBO. The best bid and offer across all markets trading an instrument is called the NBBO.
![Page 39: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/39.jpg)
Some important terms 4 The difference between the best offer and
the best bid is the bid/ask spread, or the inside spread (touch).
Orders supply liquidity if they give other traders the opportunity to trade.
Orders demand liquidity (immediacy) if they take advantage of the liquidity supplied by other traders’ orders.
![Page 40: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/40.jpg)
What are agency/proprietary orders? Orders submitted by traders for their own
account are proprietary orders.• Broker-dealers and dealers.
Since most traders are unable to directly access the markets, most order are instead agency orders.• Presented by a broker to the market.
![Page 41: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/41.jpg)
Market ordersInstruction to trade at the best price
currently available in the market.
• Immediacy• Buy at ask/sell at bid => pay the bid/ask
spread• Price uncertainty
Fills quickly but sometimes at inferior prices.
![Page 42: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/42.jpg)
Used by impatient traders and traders who want to be sure that they will trade. It is usually thought that insiders use that type of order.
When submitting a market order execution is nearly certain but the execution price is uncertain.
Takes liquidity from the market in terms of immediacy. They then pay a price for immediacy which is the bid-ask spread.
![Page 43: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/43.jpg)
Market order: Example 1
Suppose that the quote is 20 bid, 24 offered. Suppose that the best estimate of the true value of the security is 22.
A market buy order would be executed at 24 for a security worth 22.
The price paid would be 24 and therefore the price of immediacy would then be 2.
![Page 44: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/44.jpg)
Market order: Example 2
A market sell order would be executed at 20 for a security worth 22.
The price received would be 20 and therefore the price of immediacy would then be 2.
The price of immediacy is the bid-ask spread.
![Page 45: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/45.jpg)
Price improvement
Price improvement is when a trader is willing to step up and offer a better price than that of the prevailing quotes (at order arrival).
Who benefits from price improvement? Who loses from price improvement?
![Page 46: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/46.jpg)
Market impact Large market orders tend to move prices.
Liquidity might not be sufficient at the inside quotes for large orders to fill at the best price.
Prices might move further following the trade.• Information and liquidity reasons.
![Page 47: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/47.jpg)
Market impact: Example For example, suppose that a 10K share
market buy order arrives in IBM and the best offer is $100 for 5K shares.
Half the order will fill at $100, but the next 5K will have to fill at the next price in the book, say at $100.02 (where we assume that there is also 5K offered).
The volume-weighted average price for the order will be $100.01, which is larger than $100.00.
![Page 48: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/48.jpg)
Limit orders A limit order is an instruction to trade at
the best price available, but only if it is no worse than the limit price specified by the trader.
• For a limit buy order, the limit price specifies a maximum price.
• For a limit sell order, the limit price specifies a minimum price.
![Page 49: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/49.jpg)
Limit orders: Examples If you submit a limit buy order for 100
shares (round lot) of Dell with limit price of $20. This means that you do not want to buy those 100 shares of Dell at a price above $20.
If you submit a limit sell order for 100 shares (round lot) of Dell with limit price of $24. This means that you do not want to sell those 100 shares of Dell at a price below $24.
![Page 50: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/50.jpg)
If the limit order is executable (marketable), than the broker (or an exchange) will fill the order right away.
If the order is not executable, the order will be a standing offer to trade.• Waiting for incoming order to obtain a fill.• Cancel the order.
Standing orders are placed in a file called a limit order book.
![Page 51: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/51.jpg)
Limit price placement: (from very aggressive to least aggressive)
Marketable limit order: order that can immediately execute upon submission (limit price of a buy order is at or above the best offer),
At the market limit order: limit buy order with limit price equal to the best bid and limit sell order with limit price equal to the best offer,
Behind the market limit order: limit buy order with limit price below the best bid and limit sell order with limit price above the best offer.
![Page 52: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/52.jpg)
![Page 53: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/53.jpg)
A standing limit order is a trading option that offers liquidity
A limit sell order is a call option and a limit buy order is a put option. Their strike prices are the limit prices.
A limit order is not an option contract (not sold).
The option is good until cancelled or until the order expires.
The value of the implicit limit order option increases with maturity.
![Page 54: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/54.jpg)
Why would anyone use limit orders?
The compensation that limit order traders hope to receive for giving away free trading options is to trade at a better price.
However, options might not fill (execution uncertainty).• Chasing the price.
![Page 55: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/55.jpg)
Limit order traders might also regret having had their order filled (adverse selection)…• What could cause a limit order to regret
obtaining a fill?• How would this fact affect strategies
involving limit orders?
![Page 56: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/56.jpg)
Stop orders
Activates when the price of the stock reaches or passes through a predetermined limit (stop price). When the trade takes place the order becomes a market order (conditional market order).
Buy only after price rises to the stop price. Sell only after price falls to the stop price.
![Page 57: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/57.jpg)
Stop orders are typically used to close down losing positions (stop loss orders).
Mainly used on market orders and few on limit orders.
![Page 58: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/58.jpg)
Example: Suppose that the market for Dell is currently 20 bid, 24 offered.
Suppose that you place a stop loss order for 1,000 shares of Dell at a stop price of 15.
Suppose that after having placed that order, the market falls to: 13 bid, 15 offered. The bid price passed your stop price.
Your order is then executed at 13 provided there is enough quantity at that price.
The stop price may not be the price at which you are executed, as above.
![Page 59: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/59.jpg)
Difference between stop orders and limit orders
The difference lies in their relation with respect to the order flow.
A stop loss order transacts when the market is falling and it is a sell order. Therefore such an order takes liquidity away from the market (it must be accommodated so it provides impetus to any downward movement).
![Page 60: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/60.jpg)
A limit order trades on the opposite side of the market movement. If the market is rising, the upward movement triggers limit sell orders.
Outstanding limit orders provide liquidity to the market.
![Page 61: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/61.jpg)
Short sale: sale of a security that you do not own
To sell it, you must borrow it from someone who owns it. You get some cash from the sale of the security but you remain indebted to the lender for the security.
![Page 62: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/62.jpg)
The trader engaging in such a strategy expects the security to decline in value.
As, if it is the case, he will be able to buy back the security at the a price lower than the price at which he sold.
The profit margin comes from that difference in prices.
![Page 63: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/63.jpg)
Short sale - Initial conditions
Z Corp 100 Shares50% Initial Margin30% Maintenance Margin$100 Initial Price
Sale Proceeds $10,000Margin & Equity 5,000Stock Owed 10,000
![Page 64: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/64.jpg)
Short sale - Maintenance margin
Stock Price Rises to $110
Sale Proceeds $10,000Initial Margin 5,000Stock Owed 11,000Net Equity 4,000Margin % (4000/11000) 36%
![Page 65: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/65.jpg)
Short sale - Margin call
How much can the stock price rise before a margin call?
($15,000* - 100P) / (100P) = 30%P = $115.38
* Initial margin plus sale proceeds
![Page 66: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/66.jpg)
• Using only a portion of the proceeds for an investment.
• Borrow remaining component.
• Margin arrangements differ for stocks and futures.
Margin trading
![Page 67: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/67.jpg)
Maximum margin• Currently 50%• Set by the Fed
Maintenance margin• Minimum level the equity margin can be
Margin call• Call for more equity funds
Stock margin trading
![Page 68: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/68.jpg)
X Corp $7050% Initial Margin40% Maintenance Margin1000 Shares PurchasedInitial PositionStock $70,000 Borrowed $35,000 Equity $35,000
Margin trading - Initial conditions
![Page 69: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/69.jpg)
Margin trading-Maintenance margin
Stock price falls to $60 per share
New PositionStock $60,000 Borrowed $35,000 Equity 25,000
Margin% = $25,000/$60,000 = 41.67%
![Page 70: Chapter 3 How Securities Are Traded. Topics Covered How securities are first marketed to the public by investment bankers Underwriters, IPOs – Underpricing,](https://reader036.fdocuments.us/reader036/viewer/2022081519/56649d3f5503460f94a17d6c/html5/thumbnails/70.jpg)
Margin trading - Margin call
How far can the stock price fall before a margin call?
(1000P - $35,000)* / 1000P = 40%
P = $58.33* 1000P - Amount Borrowed = Equity