MIS 3090: IT for Financial Services The Market for the Next 100 Years!
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Transcript of MIS 3090: IT for Financial Services The Market for the Next 100 Years!
MIS 3090:IT for Financial Services
The Market for the Next 100 Years!
2/29April 19, 2023
OutlineOutline
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
3/29April 19, 2023
Competing Business ModelsCompeting 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 - ECN
Liquidity ProvidersNone One Many
NYSE(+ Archipelago ECN 2006)
AMEX
4/29April 19, 2023
Auction Market ModelAuction Market Model
Floor-based Single Specialist Order-driven Capital commitment
limited to one firm Trade halts for volume
imbalances
5/29April 19, 2023
Dealer Market ModelDealer Market Model
Screen-based Competing Market
Makers Quote-driven Capital commitment
from multiple firms
6/29April 19, 2023
Role of Market MakerRole of Market Maker
Compete for investor orders
Commit capital Maintain inventories Seek the other side of a
trade Trade on both sides of the
market Generate investor interest
7/29April 19, 2023
Screen-based Markets 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
8/29April 19, 2023
NASDAQ Level II ScreenNASDAQ Level II Screen
9/29April 19, 2023
NASDAQ Level II data
Shows “book” of market makersUsed by day tradersMany just follow the “ax”Potential tricks Breaking large orders up Posting false orders and pulling them Hide orders by trading through ECNs
10/29April 19, 2023
Retail “Buy” Order – Scenario 1Retail “Buy” Order – Scenario 1
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
11/29April 19, 2023
Execution – Scenario 1Execution – 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.
Retail investor wants to “Buy” 200 shares @
25.25.
“Sell”
12/29April 19, 2023
Retail “Buy” Order – Scenario 2Retail “Buy” Order – Scenario 2
Retail “Buy” MM
BID
25.00
24.87
24.86
24.85
24.84
“Sell”
Trade Report: 200 @ 25.25Trade Report: 200 @ 25.25
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
Retail investor wants to “Buy” 200 shares @
25.25.
13/29April 19, 2023
Cover Short Position – Scenario 2Cover 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”
300
Retail investor wants to “Sell” 300 shares.
14/29April 19, 2023
Execution – Scenario 2Execution – 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” 300 shares at its best bid price of 25.12
Trade Report: 300 @ 25.12Trade Report: 300 @ 25.12
Retail “Sell”
300
Retail investor “Sells” 300 shares to Market Maker.
“Buy” 300
shares
15/29April 19, 2023
NASDAQ Technology - SelectNetNASDAQ Technology - SelectNet Order delivery and negotiation system (large orders usually;
not for individual investors) 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”
16/29April 19, 2023
BID
75.25
75.24
75.20
75.19
75.18
Preferencing ExplainedPreferencing 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
LEHM
LEGG
MM
MM
LEHM
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)
17/29April 19, 2023
BID
75.25
75.24
75.20
75.19
75.18
Preferencing Explained.. cont’dPreferencing 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
Broker
CSCO
Bought 1000 at $75.25 even though bid $75.20
LEHM
LEGG
MM
MM
LEHM
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 $96m
18/29April 19, 2023
NASDAQ Technology - SOESNASDAQ 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)
19/29April 19, 2023
NASDAQ Technology - SuperSOESNASDAQ 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
20/29April 19, 2023
ComparisonsComparisons (NASDAQ vs. SuperMontage)
Quotes on one screen;Orders on another
Everything on one screen
21/29April 19, 2023
SuperMontage - featuresSuperMontage - features Shows depth of market on buy and sell side Replaced SOES and SuperSOES 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)
Scrapped in favor of Instinet in 2005 after $107M Moving to opensource
22/29April 19, 2023
SuperMontageSuperMontage PowerView ScreenPowerView Screen
QuoteView
DepthView
See http://www.tradingacademy.net/nasdaq/ for more information
(size is in 100’s)
23/29April 19, 2023
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
24/29April 19, 2023
Faster Execution Rates
Execution speed improve by almost 90%
25/29April 19, 2023
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.
26/29April 19, 2023
Other Technology: Heat MapsOther Technology: Heat Maps
27/29April 19, 2023
Opening PricesOpening Prices – – still some concernsstill some concerns
No consolidated order book for all market makers Opening prices are set between 8:15am 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
28/29April 19, 2023
Current IssuesCurrent Issues NASDAQ merged with Island/Instinet (ECN) Countered merger between NYSE and Arca|Ex Evolution of hybrid markets
29/29April 19, 2023
For Next Class…For Next Class… Read
– ECNs – check out http://en.wikipedia.org/wiki/Electronic_Communication_Network
– Articles on class website