MIS 3090: IT for Financial Services

29
MIS 3090: IT for Financial Services The Market for the Next 100 Years!

description

MIS 3090: IT for Financial Services. The Market for the Next 100 Years!. 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 market shortcomings. None. - PowerPoint PPT Presentation

Transcript of MIS 3090: IT for Financial Services

Page 1: MIS 3090: IT for Financial Services

MIS 3090:IT for Financial Services

The Market for the Next 100 Years!

Page 2: MIS 3090: IT for Financial Services

2/29April 20, 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

Page 3: MIS 3090: IT for Financial Services

3/29April 20, 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

Page 4: MIS 3090: IT for Financial Services

4/29April 20, 2023

Auction Market ModelAuction Market Model

Floor-based Single Specialist Order-driven Capital commitment

limited to one firm Trade halts for volume

imbalances

Page 5: MIS 3090: IT for Financial Services

5/29April 20, 2023

Dealer Market ModelDealer Market Model

Screen-based Competing Market

Makers Quote-driven Capital commitment

from multiple firms

Page 6: MIS 3090: IT for Financial Services

6/29April 20, 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

Page 7: MIS 3090: IT for Financial Services

7/29April 20, 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

Page 8: MIS 3090: IT for Financial Services

8/29April 20, 2023

NASDAQ Level II ScreenNASDAQ Level II Screen

Page 9: MIS 3090: IT for Financial Services

9/29April 20, 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

Page 10: MIS 3090: IT for Financial Services

10/29April 20, 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

Page 11: MIS 3090: IT for Financial Services

11/29April 20, 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”

Page 12: MIS 3090: IT for Financial Services

12/29April 20, 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.

Page 13: MIS 3090: IT for Financial Services

13/29April 20, 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.

Page 14: MIS 3090: IT for Financial Services

14/29April 20, 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

Page 15: MIS 3090: IT for Financial Services

15/29April 20, 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”

Page 16: MIS 3090: IT for Financial Services

16/29April 20, 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)

Page 17: MIS 3090: IT for Financial Services

17/29April 20, 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

Page 18: MIS 3090: IT for Financial Services

18/29April 20, 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)

Page 19: MIS 3090: IT for Financial Services

19/29April 20, 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

Page 20: MIS 3090: IT for Financial Services

20/29April 20, 2023

ComparisonsComparisons (NASDAQ vs. SuperMontage)

Quotes on one screen;Orders on another

Everything on one screen

Page 21: MIS 3090: IT for Financial Services

21/29April 20, 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

Page 22: MIS 3090: IT for Financial Services

22/29April 20, 2023

SuperMontageSuperMontage PowerView ScreenPowerView Screen

QuoteView

DepthView

See http://www.tradingacademy.net/nasdaq/ for more information

(size is in 100’s)

Page 23: MIS 3090: IT for Financial Services

23/29April 20, 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

Page 24: MIS 3090: IT for Financial Services

24/29April 20, 2023

Faster Execution Rates

Execution speed improve by almost 90%

Page 25: MIS 3090: IT for Financial Services

25/29April 20, 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.

Page 26: MIS 3090: IT for Financial Services

26/29April 20, 2023

Other Technology: Heat MapsOther Technology: Heat Maps

Page 27: MIS 3090: IT for Financial Services

27/29April 20, 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

Page 28: MIS 3090: IT for Financial Services

28/29April 20, 2023

Current IssuesCurrent Issues NASDAQ merged with Island/Instinet (ECN) Countered merger between NYSE and Arca|Ex Evolution of hybrid markets

Page 29: MIS 3090: IT for Financial Services

29/29April 20, 2023

For Next Class…For Next Class… Read

– ECNs – check out http://en.wikipedia.org/wiki/Electronic_Communication_Network

– Articles on class website