I am presuming this is quasi-legal but in some cases not? What makes it illegal? The HFTs firms pay for order flow and that is by a certain instrument? So if there is an HFT Bot making the market in certain options at a certain strike my order may go there faster than a different strike for example? Or the market maker Bot makes a certain range of strike prices? Anyway, I am not so puzzled by the legal aspects of this rather the ramifications for the market and possibly taxing the HFT traders out of business. That might bode poorly for a lot of people.
It is illegal if they don't adequately disclose it to the customer. RobinHood is under investigation over this. Many people think HFT is bad for the market. And I don't think HFTs dislikes paying for order flow if it gives them an edge...
Of course, nobody is forcing them to pay for order flow. How much of an edge, if any are they getting by that is a questionable and belated part of the OP.
Market Maker’s biggest risk is to trade against informed traders (aka toxic order flow). In contrast, trading against non-informed traders (aka dumb order flow) is license to print money. They are still subject to best execution laws, but they have the technology and the brain power (at high costs) to still make it worthwhile. Simple as that. The rest is anti-HFT fear mongering.
Yep, retail orders getting routed through say Citadel get better fills than if they used the big market. That's what everyone seems to get wrong with HFT, it's a win-win-win for everyone involved (firm selling the order flow, market-maker, and client).
If you're a big market making firm offering markets for big traders/funds you're always at risk of being massively picked off as they might know far more than you (legal information, not insider). So the spreads have to be wider to take account of this, perhaps 60-70. But no retail client, even with excellent information, is going to buy millions of dollars worth of stock from you. Hence you can tighten up the 60-70 to 63-67. In effect you have two markets, a tighter market for retail and a wider one for pros.
Well, until one of ‘em retail traders does some TCA we would not know either way. My prior would be that total cost would be a marginal improvement over an average cost of directed execution or SOR that includes non-PFOF venues. For larger traders it might be negative and I am almost certain that it’s mostly negative for any higher turnover trader. My usual point is that negative selection is a real thing and it’s very likely that over a course of thousands of trades you’ll find that despite a nominal improvement your long term results are actually worse. For example, your limit orders will mostly get filled when you don’t want them to and will not get filled when you do.
AFAIK, there are no sales of order flow in the regulated futures markets. Just putting that out there for information.