The NYSE Hybrid MarketSM plan expands execution choices. Investors and traders will be able to choose from the speed and certainty of an automatic execution or the opportunity for price improvement from the auction market. Automatic trading is a dramatic change for the NYSE: Ever since the first trade took place in 1792 under the Buttonwood Tree, the NYSE has operated an auction market. The NYSE Hybrid plan and Regulation NMS will enable the listed market to trade with the efficiency of OTC-stocks. In our three-part series, we will look at the Hybrid proposal. This month we will examine Hybrid basics â how the proposal changes the current market for liquidity takers. In subsequent issues of Equity Research & Strategy, we will look at the roles of the specialist and the floor broker and work through examples of how orders will be handled in the new NYSE structure. Hybrid â The Fast Market The NYSE Hybrid MarketSM proposal is still pending approval by the Securities and Exchange Commission (SEC). Assuming regulatory clearance, the exchange will introduce the Hybrid market in phases with the final rollout occurring in the Spring of 2006. This phased rollout, according to exchange officials, will provide the specialist, floor and market participants the opportunity to slowly get used to the new execution priority and the new ways to interact in the marketplace. NYSE Hybrid fundamentally changes how the NYSE will operate for liquidity takers. In the auction market, the specialist was primarily the catalyst for trading. The floor could participate or go along with any execution. In the new Hybrid trading rules, the auto-execution order has priority, giving market participants greater execution speed and certainty. New Order Types Three new order types are being introduced â an auto-ex order type, and Auction Limit (AL) and Auction Market orders. AL orders enable investors to send orders to the specialist in order to seek potential price improvement from the auction market.We will discuss the AL order type in more detail next month when we focus on the role of the specialist. AUTO-EXECUTION From the time the exchange officially disseminates a price until 3:59:00 P.M., all NYSE Hybrid market quotes will be subject to automatic execution unless designated otherwise (see Liquidity Replenishment Point below). To achieve an auto-execution market, the exchange is expanding NYSE Direct+®. The NYSE is eliminating the size restrictions (1,099 shares for stocks and 10,000 shares for Exchange Traded Funds [ETFs]) and the current 30-second limitation for consecutive orders. They are also creating a new âImmediate-or-Cancelâ (IOC) order type and will permit auto-ex market and auto-ex marketable limit orders to âsweepâ the NYSE Display Book®. Sweeps NYSE sweeps operate differently than in the OTC market. In the OTC market, investors are filled at each price level. In an NYSE sweep, if the sweep extends beyond the BBO, a âclean-upâ is determined and intervening posted liquidity is afforded price improvement. Letâs look at some examples. In the case of a buy, the order will execute at the offer price for the published volume. The Regulation NMS order-protection rule protects top-of-file quotations in the national market. The NYSE will sweep price-level by price-level and in accordance with Regulation NMS. The NYSE will then send orders to other market venues whose top-of-file quotation (not
the depth of book) are in the sweep (Figure 1). The NYSE will seek to internalize as much of the order as possible. Although the sweep will respect the order-protection rule for the top of file, it will not send orders to better-priced liquidity that is in the depth of book of another market venue. The SEC still must determine if the specialist can decide to add liquidity and match other âprotectedâ market venue quotations to avoid routing. Sweep orders will execute to a price level that is either the orderâs limit price, fills the order or reaches a Liquidity Replenishment Point (LRP). Clean-up Price All sweeps beyond the BBO will have two execution prints â the liquidity that was at the published BBO and then a âclean-upâ price. The âclean-upâ price is the price level that completed the order. It could be either the orderâs limit price, the level that completed the order or a Liquidity Replenishment Point. Resting bids and offers in the NYSE Display Book® between the displayed BBO and the price at which the sweep ended (the clean-up price) receive price improvement. For example, (Figure 2), a sweep from $23.96 to $23.99 will have two prints â the stock at $23.96 and the clean-up price at $23.99. Any resting orders at $23.97 and $23.98 will receive price improvement and be printed at $23.99. Liquidity Replenishment Point (LRP) â Temporary Suspensions in Auto-Execution The NYSE believes that a pure autoexecution market introduces undesirable volatility. Rather than allowing prices to gyrate at times of market stress or order imbalances, the exchange has created LRP âcircuit-breakers.â LRPs are volatility moderators that suspend auto-execution and provide the specialist, crowd and market participants the opportunity to enter orders and replenish liquidity on either side of the market. Two LRPs are proposed â a Price-based LRP (P-LRP) and a Momentum-based LRP (M-LRP). The P-LRP is a minimum of five cents from the exchange bid or offer rounded to the nearest nickel. For example, if the market is $20.10 - $20.12, the P-LRP is at $20.05 - $20.20. If the market is $20.04 - $20.09, the P-LRP would be $19.95 - $20.15. The M-LRP may be triggered if electronic trading results in rapid price movement over a short period of time. If a security has moved the greater of 25 cents or 1 percent of its price within 30 seconds, automatic trading is suspended. An M-LRP in an $18.00 stock would be 25 cents. The M-LRP in a security priced at 26.49 would be rounded down to 26 cents. The benchmark price of the M-LRP is determined by the high/low trades that occur in the prior 30 seconds. Hitting an LRP and the Resumption of Auto-Execution If the auto-ex market or marketable limit sweep order is sent tagged as an IOC order, and it hits an LRP and isnât completed (has a residual balance), then the remaining balance is immediately cancelled. Whenever an LRP is reached, auto-execution is suspended and the NYSE becomes a slow market venue. NYSE quotes at this time will be protected under Regulation NMS. During this time, when the NYSE suspends auto-execution, incoming orders and cancellations will continue to be reflected automatically in the book. When does auto-execution resume? It depends upon how the LRP was hit. If the order that caused the LRP to be hit is filled in its entirety or the remaining balance has been cancelled because it was an IOC sweep, then automatic executions and auto-quote will resume no more than five seconds from when the LRP was hit. It can resume earlier than five seconds if the specialist manually intervenes and either trades or re-quotes the market. What happens when a non-IOC sweep order hits an LRP and has a residual balance? The residual balance at the LRP will be represented in the auction market. It will be represented so that it does not lock or cross the national market quote. Automatic execution is suspended and is required to resume in no more than 10 seconds. It is expected that the specialist will quote or trade before the 10-second limit has lapsed, unless an imbalance exists or a trade is being put together by the floor. The crowd has 10 seconds to complete the trade before auto-ex resumes. The NYSE is seeking to create an integrated auto-ex/auction market. This new NYSE market structure will deliver the speed and immediacy that traders now experience in the OTC market. In the first of this three-part series, we looked at the basics of Hybrid auto-execution. Next month, in the second part, we will examine the role of the specialist and the floor broker, and how they will interact with the auto-ex and auction market orders in the Hybrid world. ■
Less than 10 percent of volume in exchange-traded funds (ETFs) occurs in auction market venues. In fact, in the 150 most active (by volume) NYSElisted securities (from March 27 to July 7) 20 percent or more of volume was executed via FAST electronic market venues â through the BLOOMBERG TRADEBOOK®, market makers and other ECNs in the NASDAQ Market CenterSM, and auto-ex venues like Archipelago Exchange. The electronic market venues are also a significant source of liquidity during times of stress â for example, when breaking news affects a stock. The challenges to executing NYSE-listed stocks are well documented. Although NYSE Hybrid and Regulation NMS will improve the market structure, they are scheduled to roll out in the Spring of 2006 â nine months! When speed, immediacy and certainty of execution are at a premium, traders may elect to avoid slow markets and trade only with the fast markets. BLOOMBERG TRADEBOOK®âs Order Handling Facility AUTO-EX order type can provide traders with this level of flexibility. The AUTO-EX order type responds only to fast market quotes. It respects the trade-through rule. Passive limit orders are posted in CQS (via NASDAQ Market CenterSM), which affords them Intermarket Trading System (ITS) tradethrough protection. The auto-ex order will not respond (send orders) to slow market centers. Rather, it will stand its ground if a slow market locks, and leverage our OTC-style Anti-Lock Breaks so that quotes will not lock or cross the national market. By standing its ground, slow market venues respond to your quote as a firm electronic ITS commitment to trade. This order type can provide a powerful new dimension to trading NYSE-listed stocks. Letâs look at some strategies. Trading ETFs Speed, immediacy and certainty are critical to ETF traders. It is, in part, one reason that ETF trading is dominated by the fast market venues. In fact, most traders find manual exchanges to be inconvenient intermediaries in an increasingly efficient marketplace. Since liquidity at a price level in these securities is typically not an issue, most traders would simply avoid manual execution venues. For ETFs, the AUTO-EX order type enables traders to trade only with the fast markets and not have their orders unnecessarily delayed by the slow venues (Figure 1). Splitting Orders between the NYSE and Auto-Ex Direct participation with liquidity on the floor of the NYSE, at times, can be critical to an efficient execution. In second-tier liquid stocks, although some liquidity may be in the third market or on the ECNs, traders still have to have access to the crowd because floor brokers may be actively assembling trades. If the order is somewhat sizeable, most traders would be reluctant to send it down to the NYSE via DOT (NYSE SuperDotSM) for fear of specialist intermediation and the potential for information leakage. Yet at the same time, by not participating in the trading on the ECNs, third market and electronic exchanges could adversely impact the orderâs average price. More and more traders are electing to use a âsplit orderâ approach. BLOOMBERG TRADEBOOK® enables traders to split their order â by electronically sending a portion of the order to the floor using
our network of independent floor brokers (Figure 2) and working the remaining quantity using the AUTO-EX order type. The floor order gives traders representation on the NYSE while the auto-ex order trades with the fragmented liquidity in the fast market venues. Since the auto-ex order type avoids the NYSE there will be no duplication of efforts. Setting up Strategic Orders Traders can set up several AUTO-EX strategies using BLOOMBERG TRADEBOOK® Strategic Orders (BTSV <Go>). The first step is typing BTSV <Go>, and clicking on the âListed Saved Ordersâ tab at the top of the screen. From here the trader can select the side, quantity, appropriate strike price and then select AUTO-EX from the Bang/Destination field. Alternatively, traders can select from several AUTO-EX orders in the BLOOMBERG TRADEBOOK® library of strategic orders. For example, traders can select/create multiple strategies for various volume levels on either side of the market. For instance, buy orders for 10,000, 25,000 and 50,000 shares that only send orders to execution with the AUTO-EX venues. Once the strategy is saved and named it will appear alongside other strategy buttons on the BMQ <Go> single security monitor (Figure 3). Traders will typically create multiple strategies for various volume levels on either side of the market, for example 10,000, 25,000 and 50,000 shares. Depending on the strategy of the trader, hitting bids and lifting offerings may be appropriate, or a specific limit price may be more desirable. Clicking on the strategy button on the BMQ screen will bring up the ticket, already populated with the appropriate order criteria. The growing percentage of liquidity trading away from the primary exchanges combined with a traderâs desire for immediacy and minimal intervention makes the auto-ex order type a requirement for the active listed trader. Traders want and need to be able to execute quickly against available liquidity rather than wait for a specialist to fill orders. The extent of automation at the NYSE following the introduction of the Hybrid model is uncertain. Traders need the flexibility of the OHF and autoex order type to work their orders where they feel they are able to seek the best execution for their particular strategy.
In last monthâs Equity Research & Strategy, we focused on the liquidity taker â how an electronic auto-execution order would interact with the NYSE Hybrid Market.SM We explained how a âmulti-price-level sweepâ would be awarded two prices â the best bid/offer (BBO) and a âclean-upâ price. Beyond the BBO, all executions would be cleaned-up â awarded the price level at which the sweep stopped. In auction market terms, this would be similar to the NYSE conducting mini-Dutch auctions for multiprice- level sweeps. The clean-up price provides price improvement to resting limit orders involved in a sweep â and can serve as an incentive for investors to add depth to the NYSE market. In this monthâs issue, we focus on what actually happens to orders on the NYSE book. How does the NYSE matching algorithm actually work? It is very different from the traditional strict time/price priority in OTC market venues (ECNs, ATSs, electronic exchanges, etc.) and the trading rules on the global electronic exchangesâ matching engines. Hybrid follows Priority, Parity and Precedence. There are three constituent groups in the NYSE market â the public NYSE Display Book®, the floor broker and the specialistâs dealer account.We are going to focus on the role of the specialist in next monthâs Equity Research & Strategy. The Role of the Floor Broker The NYSE Hybrid MarketSM is designed so that floor brokers can continue to represent their customers in the auction market as they do today â work-up trades and negotiate prices without being required to disclose their intentions to other participants. They can use their judgment and represent/work large orders on behalf of their clients both electronically and in person and on the trading floor. Floor brokers can represent orders in the electronic market (making them available to auto-execution sweeps, etc.) via a âBroker Interest File.â The interest file is an electronic placeholder. Because the brokers tend to represent large orders, the NYSE has provided them with âReserveâ functionality. To use Reserve, the floor broker has to display a minimum of 1,000 shares. For example, if the broker is working a 25,000-share order, he has to display a minimum of 1,000 shares and the balance (24,000 shares) can be undisplayed in Reserve. The broker can have âinterestâ (with a Reserve component) at varying price levels. Additionally, the floor brokerâs display interest will not be publicly disseminated to the public unless it is at the BBO. The floor broker is only permitted to have interest in only one crowd (or station position) at a time. The NYSE will be reconfiguring the trading posts to accommodate five stocks. Priority, Parity, Precedence The controversy of Hybrid stems the application of Priority, Parity and Precedence (Rule 72 in Amendment 5 â Federal Register, June 29, 2005). To understand how this execution hierarchy operates, letâs work through an example (Figure 1). Letâs assume that the market is 99.27-28, 1,000 x 1,000. Letâs assume that you are the first bid at 99.26 for 1,100 shares. A few seconds later, another public order arrives for 500 shares. Floor broker A places broker interest for 1,000 shares (with 10,000 shares in Reserve) and then floor broker B places interest at 99.26 for 1,000 shares (with 49,000 shares in Reserve). The publicly
disseminated display book at 99.26 is 1,600 because the floor broker interest is only disseminated when it is at the BBO. Now, the 99.27 bids get hit and the market is 99.26-28. All of the broker interest is now disseminated and the market is 99.26-28, 3,600 x 1,000. Priority â The first bid has priority for the first incoming order. The priority in the execution queue is for display â Reserve is at the end (Figure 2 â Part 1). Letâs assume that two auto-execution orders arrive within a millisecond of each other to hit the 99.26 bid. The first incoming order is for 100 shares and the second one for 3,000 shares. Being first at the level gives you priority for the first order that comes in â in this case the 100 shares â but your order will not be completed with the second incoming order of 3,000 shares. After the 100-share trade âclears the floorâ (the NYSEâs terminology for when the trade is matched), the book flips to parity in order to get ready for the ânext auctionâ for the next incoming order. Parity â The auction market takes over â all orders at the price level âGo-Alongâ and share in subsequent executions. The book (Figure 2 â Part 2) takes on a different form. The public book (your remaining 1,000 shares and the 500 shares that arrived after your order) are represented together and each broker interest joins in parity. So when the 3,000-share order arrives, it gets shared. The public book gets 1,000 shares and the two broker interests each get 1,000 shares (Figure 2 â Part 3). In the public book, you and the other bidder at 99.26 each RECEIVE 500 shares. You remain on the bid for 500 shares. Note, all disclosed interest trades before Reserve. So if the incoming order was larger than 3,000 shares, only the 1,000 shares per broker would be on parity â broker Reserve would trade only after your order was completed. Letâs assume that the incoming order is only 2,500 shares. Again, the market is on parity so the trade gets split three ways â the public book getting 834 shares (with your order and the other public order receiving 417 shares each) and the two broker interests getting 833 shares each. If the market goes to 99.27 bid again, the display at 99.26 level remains on parity â so if the market goes back to 99.26 bid, the three books will share the incoming order. If another order arrives at 99.26, it will be placed in execution priority ahead of the broker Reserve at the level, but behind the displayed orders that are on âparity.â The Global Exchanges In contrast to Priority and Parity, the global electronic exchanges would execute in time/price priority. The first order of 100 shares would execute with your order. The second order of 3,000 shares â 1,000 would execute with your order, 500 toward the second public order, then 1,000 would go to the floor broker A and 500 to the floor broker B. Precedence â Provisions for size Rule 72 discusses a concept called âprecedence based on size.â This means that a bid or offer that can trade with the entire size of an incoming order may supersede lesser-sized orders. In todayâs auction market, this practice is rarely employed â as the specialist typically enables floor brokers at the same level to Go-Along with the trade so they donât miss out on prints. Itâs not clear how this provision would be implemented in the Hybrid-matching algorithm. Hybridâs matching algorithm will be unique among markets that offer electronic access. Global exchanges, ECNs, ATSs and other electronic exchanges typically employ time/price priority when matching orders. The NYSE believes that the auction market adds value to the execution process and has designed a system to replicate electronically what happens generally in the auction market today. Priority, Parity and Precedence enable orders to share in execution prints, much like the auction process. NYSE Hybrid introduces more execution choices. Regulation NMS creates a level playing field for market venues to compete. Thus, investors will be able to choose if time/price or Priority, Parity and Precedence is best for their order.
Here's a couple of articles that I found from Bloomberg regarding the NYSE-ARCA merger. Have fun reading 'em.
I read the actual pdf version (much easier to read) and have a couple thoughts. Isnt order parity totally unfair? Does any other market operate not on a first come first serve time based priority? So what if the first order is priority filled, what if its 100 shares and the next fill is 5000 shares? I really dont understand how its fair that i get in line after everyone else has been waiting and split the fill with people. Also, I was under the impression orders represented on the book get filled before floor brokers not displaying on the open book, so now i have to split fills with them? Again, i need help with this logic. Second, the clean up price on large sweeps also seems ridiculas. If i list on the offer to go short, for instance, and a large market order comes in and needs to take out the next 4 price levels to fill, i would be filled at the inside price while the people offered 1 and 2 cents higher get price improved to the 3rd cent, while im offside 3 cents instantly? Why is that fair. There would be more incentive for me to list a cent higher and never be at the inside price for opening long/short positions because i would constantly be offside a few cents by some big order not improving me. Any help on why they decided on these features would be helpful.
It is unfair and that is the point. I read these concerns in a few articles a while ago and it's quite interesting. With these new BS rules, the NYSE can preserve & protect their racket while at the same time throw the traders & programs against each other in the fast electronic market. Whenever needed, the specialist will step in and the good ole boys will execute what they need, steal their cut and then let the electronic market with pennying fighting continue. The floor get priority on fills when it goes into auction mode and separate the electronic orders from the floor orders unlike it is now where the book gets priority based on time and price (except block prints). And the game continues.