http://www.evergreen.loyola.edu/~pptallon/is356.htm
IS 356
IT for Financial Services
The Market for the Next 100 Years!
© Paul Tallon
July 13, 2017
2/28
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
© Paul Tallon
market shortcomings
July 13, 2017
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Competing Business Models
Liquidity Providers
None
Spear, Leeds & Kellogg (ECN)
Terra Nova Trading, LLC
One
Many
NYSE
NASDAQ
B-Trade Services LLC
The Brass Utility, LLC*
Strike Technologies LLC*
(+ Archipelago ECN)
Attain-ECN
PIM Global Equities – ECN
Direct Edge
BATs
+
AMEX (2008)
© Paul Tallon
(+ Island/Instinet)
July 13, 2017
Merger w/ AMEX 11/98
(later AMEX spun off)
4 / 32
Auction Market Model

Floor-based
 Single Specialist
 Order-driven
 Capital commitment
limited to one firm
 Trade halts for volume
imbalances
© Paul Tallon
July 13, 2017
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Dealer Market Model

Screen-based
 Competing Market
Makers
 Quote-driven
 Capital commitment
from multiple firms
© Paul Tallon
July 13, 2017
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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
−
© Paul Tallon
The network is the market – attack the
network and the market will suffer
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NASDAQ Level II Screen
© Paul Tallon
July 13, 2017
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Retail “Buy” Order
ASK
BID
Retail
“Buy”
AA 25.00
MM 24.87
CC 24.86
BB 24.85
DD 24.84
Retail investor
wants to “Buy”
200 shares @
25.25
© Paul Tallon
MM
200
25.25 CC
25.28 BB
25.29 DD
25.31 AA
25.50 MM
Market Maker
has 200 shares in
inventory.
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Execution – Scenario 1
Retail
“Buy”
BID
ASK
25.00
25.25
24.87
24.86
“Sell”
MM
200
25.28
25.29
24.85
25.31
24.84
25.50
Retail investor
wants to “Buy”
200 shares @
25.25.
Market Maker fills
“Buy” order at
best offer price of
25.25.
Trade Report: 200 @ 25.25
© Paul Tallon
July 13, 2017
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Retail “Buy” Order – Scenario 2
Retail
“Buy”
BID
ASK
25.00
25.25
24.87
“Sell”
Retail investor
wants to “Buy”
200 shares @
25.25.
MM
25.28
24.86
25.29
24.85
25.31
24.84
25.50
Market Maker does not have shares in
inventory. Market Maker sells short 200
shares at 25.25.
Trade Report: 200 @ 25.25
© Paul Tallon
July 13, 2017
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Cover Short Position – Scenario 2
Retail
“Buy”
BID
ASK
25.12
25.25
25.00
MM
24.87
25.27
24.85
25.28
24.84
25.50
Market Maker raises its “Bid”
price to build inventory which
affects other prices.
© Paul Tallon
Retail
“Sell”
25.26
July 13, 2017
200
Retail investor wants
to “Sell” 200 shares.
12 / 32
Execution – Scenario 2
BID
ASK
25.12
25.25
25.00
MM
Retail
“Sell”
25.26
24.87
25.27
24.85
25.28
24.84
25.50
“Buy”
200
shares
Market Maker “Buys” 200 shares
at its best bid price of 25.12
200
Retail investor
“Sells” 200 shares to
Market Maker.
Trade Report: 200 @ 25.12
© Paul Tallon
July 13, 2017
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Preferencing Explained
you buy from
me at this price
I buy from you
at this price
BID
ASK
GLDM
75.25
75.30
LEGG
LEGG
75.24
75.31
SCHB
MM
75.20
75.32
GLDM
SCHB
75.19
75.35
MM
75.18
75.39
MM
Retail
Retail
“Sell”
“Buy”
1000
Preferred
arrangement
75.20 – 75.35
Broker
Broker receives order
to sell 1000 CSCO at
best market price. He
asks MM to buy them.
© Paul Tallon
CSCO
Best bid in the market at this
point is $75.25 so broker must
sell at this price and no worse.
MM buys at $75.25 and kicks back to broker
$0.005 per share or $5. (1M shares daily = $1.2M yr)
July 13, 2017
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Preferencing Explained.. cont’d
CSCO
MM
Retail
“Buy”
Brokers
Buy 2 x 500
from MM
Broker
Bought 1000 at $75.25
even though bid $75.20
Sales
Purchases
Kickback
Profit
Per day 1m
Annually
© Paul Tallon
$75300
$75250
$5 + 2x$2.50
$40 per trade
$40,000
$9.6m
BID
ASK
GLDM
75.25
75.30
LEGG
LEGG
75.24
75.31
SCHB
MM
75.20
75.32
GLDM
SCHB
75.19
75.35
MM
75.18
75.39
Best offer in the market at this point
is $75.30 so market maker must sell
at this price and no worse.
MM sells at $75.30 and kicks back to brokers
$0.005 per share or $5. (1M shares daily = $1.2M)
July 13, 2017
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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
−

© Paul Tallon
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”
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NASDAQ Technology - SOES
(small order execution system)






© Paul Tallon
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.
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NASDAQ Technology - SuperSOES






© Paul Tallon
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
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Comparisons (NASDAQ vs. SuperMontage)
Quotes on one screen;
Orders on another
© Paul Tallon
Everything on one screen
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SuperMontage - features





© Paul Tallon
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)
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SuperMontage PowerView Screen
DepthView
QuoteView
(size is in 100’s)
© Paul Tallon
July 13, 2017
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Higher Fill Rates


© Paul Tallon
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
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Faster Execution Rates

© Paul Tallon
Execution speed improve by almost 90%
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Greater Depth and Use of Reserve


© Paul Tallon
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.
July 13, 2017
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Other Technology: Heat Maps
After-hours quotes…
© Paul Tallon
July 13, 2017
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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
© Paul Tallon
July 13, 2017
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Intra-day Volatility (NYSE)
October - December 1999
Half-Hour Volatility
1.60%
The First 1/2 Hour
1.20%
0.80%
0.40%
3:
30
-4
:0
0
3:
00
-3
:3
0
2:
30
-3
:0
0
2:
00
-2
:3
0
1:
30
-2
:0
0
1:
00
-1
:3
0
12
:3
01:
00
30
12
:0
012
:
00
11
:3
012
:
30
11
:0
011
:
30
00
10
:3
011
:
10
:0
010
:
9:
30
-1
0:
00
0.00%
Source: Robert Schwartz, Baruch College, 2008
© Paul Tallon
July 13, 2017
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Intra-day Volatility (NASDAQ)
October - December 2000
The First 1/2 Hour
2.00%
Half-Hour Volatility
1.50%
1.00%
0.50%
00
3:
30
-4
:
30
3:
00
-3
:
00
2:
30
-3
:
30
2:
00
-2
:
00
1:
30
-2
:
30
1:
00
-1
:
00
12
:3
01:
12
:0
012
:3
0
11
:3
012
:0
0
11
:0
011
:3
0
10
:3
011
:0
0
10
:0
010
:3
0
9:
30
-1
0:
00
0.00%
Source: Robert Schwartz, Baruch College, 2008
© Paul Tallon
July 13, 2017
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8:
00
-8
:3
0
8:
30
-9
:0
0
9:
00
-9
:3
9:
0
30
-1
0:
00
10
:0
010
:3
10
0
:3
011
:0
11
0
:0
011
:3
11
0
:3
012
:0
12
0
:0
012
:3
12
0
:3
01:
00
1:
00
-1
:3
0
1:
30
-2
:0
0
2:
00
-2
:3
0
20
:3
03:
00
3:
00
-3
:3
0
3:
30
-4
:0
0
4:
00
-4
:3
0
Half-Hour Volatility
Intra-day Volatility (London)
January - May 2000
3
© Paul Tallon
The First 1/2 Hour
2.5
2
1.5
1
0.5
0
Source: Robert Schwartz, Baruch College, 2008
July 13, 2017
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9:0
09:3
0
9:3
010
:00
10
:00
-1
0:3
0
10
:30
-1
1:0
0
11
:00
-1
1:3
0
11
:30
-1
2:0
0
12
:00
-1
2:3
0
12
:30
-1
:00
1:0
01:3
0
1:3
02:0
0
2:0
02:3
0
2:3
03:0
0
3:0
03:3
0
3:3
04:0
0
4:0
04:3
0
4:3
05:0
Cl
0
os
in
g
Ca
ll
Half-Hour Volatility
Intra-day Volatility (Euronext)
January - May 2000
1.4
1.2
© Paul Tallon
The First 1/2 Hour
1
0.8
0.6
0.4
0.2
0
Source: Robert Schwartz, Baruch College, 2008
July 13, 2017
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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
© Paul Tallon
July 13, 2017
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For Next Class…

Read
–
ECNs – check out
http://en.wikipedia.org/wiki/Electronic_Communication_Network
–
© Paul Tallon
Articles on class website
July 13, 2017
32 / 32