Tagged: stock exchanges

Squab and Thanks

About 60% of US trading takes place on stock exchanges, the other 40% in private broker-operated markets. Should you be worried that nearly half of trading isn’t transparent?

It’s Thanksgiving week so there’s no need for worry! We’re in Vail marking the occasion because everything is better up high, and we’re grateful. And I think we’re entering a period of marked cooperation among exchanges, brokers, regulators and issuers, reason to be optimistic.  More on that in a moment.

Back to the question, worry stirs because there’s a notion that stock-trading in private markets called dark pools gets missed in reporting. Put that fear to rest. All trades are reported so there’s a consolidated volume figure for the day.

Let’s take an example.  Alcoa, you’re it, because your ticker is AA and easy to study. AA recently has traded about five million shares daily. Fidessa’s Fragulator says 59% of AA trading is at stock exchanges, with about 26% at NYSE-operated venues and the rest scattered across other stock markets.

The remaining 41% matches at dark pools or with brokers getting stock-trading orders internally and pairing buyers and sellers within the firm.

All trades are aggregated under reporting rules to create the observable five million shares of daily AA trading volume.

Why are investors and traders going multiple places to buy or sell AA instead of trading in one place?  A bit more math shows us.  AA trades over 28,000 times every day in roughly 175-share increments.

Data from Finra on how AA trades in dark pools or matches privately at brokers (gets “internalized”) shows trade sizes of 531 shares and 329 shares respectively.

That means the average AA trade at exchanges is tiny, near 100 shares. Arbitragers are behind a lot of those because they want to buy and sell as little as needed to change the price. While average market trade size is about 200 shares, a chunk of stocks trade under 100 shares at a time on average – a huge challenge for investors.

And there you have it. Big investors trying to buy and sell in size have no choice but to go where the average trade may be three to five times larger. It’s just efficient. That tells us too that there’s proportionally more investment behavior at brokers than what you see at exchanges.

What’s the good news here?  I don’t think I’ve seen exchanges so united behind bettering conditions for investors. All of them have publicly called on regulators for better market rules that help public companies do what they’re trying to do: Match compelling stories to long-term money via the mechanism of a public stock market.

That’s cause for thanks this season. I’ll go one further: I think we might in 2018-19 see Shangri-La:  A revamped 13F reporting structure with monthly long and short positions. The idea is percolating.

So, eat your stuffing and squab soaked in gravy, and go your way this 2017 Thanksgiving with happiness.  The market is weird, yes. Overpriced, yes. But there’s good news out there too.

Auctioning Profits

What’s the closing auction worth?

A member of the investor-relations profession last week posted a story for community discussion on a CBOE BATS proposal to open day-end auctions to exchanges that don’t have listings.

Right now rules say only the listing venue, largely the Nasdaq and the NYSE, can host end-of-day trades that many investors count on for prices that best track broad measures like the S&P 500 and Dow Jones Industrial Average.  BATS is trying to change it.

First, what’s the closing auction? Near the end of the trading day, exchanges that list stocks start providing data on buy and sell orders that want to get the last and best price.  All three big exchange groups host them – the NYSE, Nasdaq, BATS – and new entrant IEX has gotten tacit approval for its closing auction ahead of listings.

All three big groups have rules around what kinds of orders are included, but generally they are “market on close,” or a trade that takes the best price to buy or sell, or “limit on close” trades that only execute if the specified price matches the market.

BATS is the earliest in providing data and starts sending five-second updates on buy and sell imbalances at 3p ET. The NYSE and the Nasdaq follow at 3:45 and 3:50p ET respectively, also every five seconds.  Have you noticed how prices can change significantly in the last hour and especially last 15 minutes? There’s your reason.

Oversimplifying, right at 4p ET everywhere, buy and sell interest is matched at an average price. The NYSE calls it an auction, BATS uses a Dutch Auction (averaging all prices, excluding outliers) and the Nasdaq calls it the Closing Cross.

Now it gets interesting. This mass closing trade for NYSE stocks happens only at the NYSE and ditto for Nasdaq-listed shares.  BATS has proposed to the SEC that they be able to match trades in NYSE and Nasdaq stocks in the closing auction.

This at root is why exchanges want your stock-listing, public companies. It’s where the money is made.

The listing exchanges are outraged. Who can blame them? All the more when you understand the economics. Save at the open and close, trading at the exchange is a low-margin and often money-losing business.

They pay high-speed firms to set the best bid to buy or offer to sell. They’d flinch at my description but that’s the truth. Rules cap what exchanges can charge for trades at $0.30/100 shares.  But they can pay incentives well beyond that. The big exchanges have incentive tiers and platforms for high-volume customers paying up to $0.45/100 shares. They lose money on these.

Why would they do that? Because all trades in your stocks must match between the NBBO – the national best bid or offer. It’s a central tenet of Reg NMS, which governs markets. Exchanges pay some traders to be honey that attracts the bees.

The exceptions are the opening and closing auctions. Here, all the order flow ends up between the bid and offer by rule at some average price, and exchanges do not pay incentives because they have a monopoly in their listed stocks.

In fact, they charge about $0.09/100 to both the buyer and the seller ($0.18 total), meaning they make more in the auctions than any other time. Easy money.

Nearly 10% of trading occurs in the closing auction because it offers indexes and ETFs trying to “peg the benchmark” the best chance of getting prices nearest the index they’re tracking.

With about 6.5 billion shares trading daily marketwide and roughly 2.6 billion of it at the NYSE and Nasdaq, and 10% of that in the close, you can get to roughly $150 million of potential revenue annually for the big exchanges in these auctions. These are our estimates, mind.

But that’s not the half of it. Literally. Hosting the closing auctions drives two other vital revenue streams for big exchanges. First is a share of revenue from the Consolidated Tape Association.

The Tape Plan, as it’s called, divides revenue from data generated by stock tickers (you look up a ticker, you’re driving exchange revenue). It’s hundreds of millions of dollars yearly for members.  It’s apportioned by quote-share and trade-share in stock symbols. The closing auction gives the NYSE and Nasdaq a disproportionate part.

Second and data-related, prices from the closing auction comprise valuable data, and brokers are required to buy it to prove they matched best prices. The most precious product exchanges sell is data. And it’s vital to profits, since trading is a commodity.

The Nasdaq earned $108 million of net income in fiscal 2016, NYSE parent ICE, which is less reliant on equity trading, about $250 million. Take $250-$300 million (that they split) away – figuring data is double closing-auction trading revenue – by fragmenting the close, and the bottom line for both is hampered.

It’s an estimate. But follow the money and this is where it leads.

I can make the argument both ways. Fragmenting imbalance data by spreading the auctions out could mean mispricing. That to me is the leading argument against the BATS proposal.  Conversely, BATS would argue that it’s using the same pricing data so it merely increases access and removes an unfair advantage from listing exchanges – which could help you pay lower listing fees, issuers.

The bottom line is you need to know how the market works. Otherwise you cede control of it to parties wanting to profit on your prices.  That’s not in the best interest of your shareholders.

The Death Star

Last Sunday treated us to a picture-perfect Santa Monica day.

We were there helping investor-relations folks at the NIRI Fundamentals conference understand the stock market.

Of it, you probably won’t say to your CFO, “I bet you have no idea how our stock trades.” But it’s bad news if you’re asked by the CFO and have no answer.

So let’s talk about the Death Star. That’s what the industry bemusedly calls today’s trading environment.  The stock market is not at the corner of Broad and Wall or in the heart of Times Square.  It’s in New Jersey on banks of computers at several massive colocation facilities connected by superfast telecommunications infrastructure.

DeathStar

The Death Star (courtesy IEX, T Rowe Price)

The three big exchange groups today each operate four stock markets on those giant computer arrays. Suppose Nordstrom ran four stores in the mall rather than one. We’d think: “Why don’t they put the stuff in one place so customers can easily find it?”

Good question. We’ll answer it in a moment.

BATS Global Inc. is the largest stock exchange in the US now by market-share with its four platforms. Yet it lists only its own shares and exchange-traded funds. ETF trading is good business.

At two of them, traders are paid to buy shares, and at the other two they’re paid to sell (fees differ). This paying traders to buy or sell is called Maker-Taker/Taker-Maker.  Now, the Chicago Board Options Exchange is buying BATS Global.

The Nasdaq also pays traders one place to sell and pays them another place to buy. The Nasdaq is the largest options-market operator. Now the Nasdaq and the CBOE will both run large options/equities trading complexes with fees and credits that encourage traders to do opposite things in different spots, which is arbitrage.

The NYSE is owned by Intercontinental Exchange, and equity trading and listing are fragments of a global revenue colossus in derivatives helping financial players manage risk. ICE is also a huge technology and data purveyor.

By operating multiple platforms, the exchanges can set the best bid or offer, the market’s singular entry point, more often.  Each market then has unique data to sell to brokers and other exchanges, which in turn are required by rule to prove they’re giving customers the best prices – which means they have to buy the data.

There’s your answer. Exchanges operate multiple markets because they make money by changing the prices of everything and encouraging profits on differences. By promoting the arbitrage that vexes you in the IR chair, they sell data and technology.

The only exchange solely offering equity trading and listing that’s not intertwined with derivatives and influenced by trading incentives to set the bid and ask is the newest, IEX.  For our view on IEX and much more, catch the Chicago NIRI chapter’s webcast Friday.

The starting point for understanding any business is recognizing how it makes money.  The Death Star is an inferior capital-raising mechanism (it could be good again with rule-changes issuers should push).  Today, companies like Uber and Facebook grow giant on private equity and use the public market as an exit strategy.

Microsoft and Intel were like reality TV for stocks, taking everyday investors on the long and exciting process of growing in public for all to see and own. We can quibble over causality for this divergence. Our systems monitor the Death Star. It favors trading.

When you understand the Death Star, you arrive at this sort of answer for the CFO: “Since investors and traders can only trade at the best price, our price is most times set by the fastest machines. The big exchanges pay them to set the price so they have price-setting data to sell. They also encourage customers to engage in arbitrage.

“Occasionally active investors shoulder through the arbitrage.  Waves of asset-allocation flows can dominate.  A lot of the time derivatives lead because everybody is focused on managing risk, and in that process short-term divergences develop, which can be traded for profit. And this is why you need an IR professional more than ever.  Somebody has got to understand the Death Star.”

It’s easier to say, “I’m not sure but our story is central.”  It’s just not true most times.

Every IR gal or guy faces this moment of truth: Do I mail in the pat answer, or do I assail the battlements of convention and learn about the Death Star?

You can change your stars, as the Heath Ledger movie A Knight’s Tale asserts. Consistent metrics resonate with executives. If last week Active money led and Sentiment was Neutral, 5.0/10.0, and short volume was down, driving gains, they’ll want to know how those metrics changed this week. Measure and report.

They’ll look to you for the next episode of Star Wars, so to speak. That beats watching the stock or getting sent by them on wild goose chases for answers.  Embrace the change.

Speaking of change, we plan to launch in coming weeks daily sector reports highlighting key metrics – Sentiment, Key Behavior, Short Volume, etc. – for the eleven big industry classifications so you can see what’s happening in your group and how you compare.

There’s much more, so stay tuned! And don’t fear the Death Star.

Exchanges Depend on Arbitrage

What if some mathematical calculations in the market are just there to get a reaction?

Traders have not to my knowledge named them “Charlie Sheen.” But alert reader Walt Schuplak at the Market Intelligence Group in New York sent an item about rogue algorithms. Our friend Joe Saluzzi at Themis Trading wrote on it yesterday.

Joe explains that certain trading practices create arbitrage opportunity. Profiting from divergence isn’t bad of itself, Joe notes. But if the chance to profit is fostered where divergence could not or would not occur on its own, it raises fundamental questions.

Bloomberg writer Nina Mehta wrote today about the Australian government’s initial rejection of the Singapore Exchange’s effort to buy the Oz stock market. Singapore is a shareholder-owned exchange. The Deutsche Bourse is public. Same with the InterContinental Exchange, throwing in with the Nasdaq on a bid for the NYSE, both of which are public too. The London and Toronto markets are run by public companies. BATS may IPO. (more…)

CEOs Need to Be Asking Questions

In Denver, summer’s retreat this year toward the Continental Divide has been languid, its ambling trail marked by fiery aspens and long warm days.

But in the markets, pension funds have given stocks the cold shoulder, and fast. So says an article in the Wall Street Journal Monday, which traced the defection at noteworthy major corporate plans. Stocks comprise but half of plan assets now at best, and pensions themselves are in rapid decline as companies shift from defined benefits. (more…)