• Feb
  • 15
  • 2007
  • 5:03 PM

More on the moron post

By: Ray Pellecchia
File Under: NYSE, NYSE

To date, at least a dozen people have commented on The moron weighs in. I can't respond to all of them individually, but I do thank every single one for writing, and I do want to pick out a few questions that need to be answered, and offer my humble perspective on some things.

I was in the midst of putting together one long response to the various questions, because a number of them are related. But people are now writing in for answers sooner rather than later, so I'm going to respond on a piecemeal basis as I get the answers. Here are the first couple.

How much of Hybrid is actually using ArcaEx technology/systems?

Will Hybrid eventually include derivitives or will it be used exclusively for equities?

What are your thoughts on Goldman Sachs' view that initial volume is lower than they forecasted?

Thanks in advance for your insight?

-- bk

BK -- The only NYSE Arca technology being used for the NYSE Hybrid Marketwill be the smart order router, which will be used for auto-routing order to other markets when Reg. NMS becomes effective on March 5.

The Hybrid model of trading is being used for all NYSE-traded securities: equities and ETFs. Other securities, such as options, are being traded on our NYSE Arca platform.

On the forecasts, sorry, I don't comment on analyst reports. If you want to see the latest monthly volume statistics, here's the latest.

With the new LRP change the NYSE is now just an ECN with no incentive to trade on. As already stated why would the NYSE do this if they already own ARCA? This might sound drastic but at this point it might be better to just scrap the Hybrid as i dont really believe that phase iv will change anything for the better. For those who prefer fast execution they can use ARCA, for others who prefer matching & price improvement they would have the traditional system. Best of both worlds. With the current Hybrid its the WORST of both worlds. Thanks.

-- tony dey

Tony -- Sorry, no can do. There is no putting the genie back in the bottle, for two reasons:

1) As mentioned here a number of times, particularly in the early going, our biggest customers wanted us to offer the ability to trade automatically. If we weren't responsive to this, they would have sought other venues. Don't think we didn't try to address this in other ways. The old Direct+ was one such effort, but with its limitations, and without the ability to sweep, it didn't fill the bill.

A few of you have written and said that unless we make changes, you're going elsewhere, and then what do we have left? I understand and respect that. But the same principle applies to our biggest customers. If we had told all of them to go elsewhere -- even to use NYSE Arca -- NYSE would not have lasted very long.

That being said, NYSE has always attracted a broad range of customers, and that continues to be our aim. That's the reason we built price improvement, matching and other tools into the Hybrid, for people who prioritize price, such as yourself. The fact that they're not being used as much as we'd like is an unintended consequence of the changes taking place. I'll explain that more fully below.

2) Reg. NMS. Come March 5, any market can trade through a better price in another market if that better price is not automatically accessible. If NYSE had decided to stand pat from February 2004, when the concepts of Hybrid and Reg. NMS were introduced, our best prices would be traded through constantly. Effectively, there would be little or no volume left here.

I gotta say, and I'm not singling you out on this, Tony (my truly faithful correspondent since Day 1), but to everyone who has written in recently to suggest going back to square one or lamenting the lack of specialist participation, I wish you had spoken up sooner.

Looking through the hundreds of comment letters on Reg. NMS and Hybrid submitted over the course of two years, how many are from day traders and prop. traders? As far as I can see, there are none. People are telling me in this space that they depend on price improvement from specialists for their livelihoods and to put food on their tables. If that's the case, it would have been helpful for the SEC to hear that, at a time when specialists didn't appear to have a friend in the world, at a time when everyone was screaming for auto-ex and no one seemed to care about best price, much less price improvement.

Your voices are being heard today, via this here blog. But if you were present in the rulemaking and design process, it would have been so much the better.

One problem we've seen -- the unintended consequence I mentioned -- is that so many restrictions on specialist trading had to be built to address concerns about specialist trading, that the pendulum has swung way in the other direction. Their s-Quotes are too often getting to the market behind everyone else's bids and offers, thereby missing the market and missing the opportunity to provide price improvement or match. We are looking at this and other circumstances that could be causing specialists to participate too little, and how they might be addressed.

For those who have said you need the solutions NOW, I don't have them. All I know is that we're going to continue to work on it, that it's top priority here, and that I'll share with you what I know, as soon as I know it.

I guess I digressed there and started answering some other questions. Hey, again, this is best efforts. More to come.

Also, for those who are hitting me on the trivia items I toss out here, sorry, I'm going to keep at it, because a number of people tell me they enjoy it and hear it talked about at conferences, it's now a hallmark part of this conversation, I enjoy it, and it's down at the end of each post, so if you don't like it, quit reading at the part where I say:

A bit of historical trivia for your Thursday afternoon, folks:

Today in NYSE History
15 Feb 1840 A committee was appointed to consider building the NYSE a permanent home. (Instead, the Exchange remained in rented quarters for another 25 years.)

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Comments

Ray, I have written letter after letter to the SEC and even sat down with congress men & women from the move to trade in pennies to Reg NMS. I really thought ex SEC boss Donaldson was going to fix the problems but he said there was too many politics involved. A few bad specialists hurt the whole exchange but they threw out the baby with the bathwater. Thats the past but what now? The Hybrid clearly is not working to the best of its ability right now. As customers of the NYSE we need more matching & price improvments for better fills or the NYSE will lose customers and volume which i believe is happening right now. I still dont know the percentage of trades that are being matched now but it must increase dramatically or customers will route away. Will this change in the near future or not? Also, this blog is fairly new so we didnt have a forum to comment. Thanks for your time.

by tony dey on February 15, 2007 5:29 PM

Ray, you are right about one thing - nobody stepped up to the plate to defend the specialists. I have been a vocal proponent of the specialist system for years, and lamented the fact that they became scapegoats for the regulators. I agree with your take that the specialists have been neutered by all this regulation, and it doesn't allow them to provide value to the markets. Specialists and specialist firms must have an incentive to participate, and that simply doesn't exist in this market. It is ironic that the NYSE changed to the hybrid system in response to the same "large customers" who are now deserting the exchange to cross stock off the floor and in dark pools. I'll tell you also, when solutions will be brought to the table. I'll be after the next big bear market, when the public and regulators and politicians scream for a new scapegoat - the cascade of electronic sell orders that "caused" the panic selling. No person there to mitigate it. Then the pendulum might swing the other way. Depending on when that is, we may or may not be here talking about it. Btw in a way the stock exchange is transparent - anybody can see there is diminished liquidity there now.

by jack on February 15, 2007 6:28 PM

Ray,
Thank you for your response. Very insightful.

A couple other questions about NYSE Arca and options as it pertains to NMS. Does the trade through extend to the options markets as well?

And finally, is there a link where we can track market share/volume numbers for NYSE Arca's options?

Thanks in advance for your insight. Also, thanks for this resource.

bk

by bk on February 15, 2007 10:55 PM

Ray,

While I can't speak for others, when the proposed market changes came along I actually thought it was a good idea and agreed with what was, then, being proposed. What with the blatant manipulation, front running, etc by the specialists; how could I not? Come to think of it how much did they get fined? 240 mil? Peanuts to them, because it would be foolish to assume the regulators caught them all. I would be remiss not to mention that not all the specs were like that. In fact some were kinda nice and did not play games.

So, during the comment periods I did not feel it was necessary to make one. I felt the NYSE was finally taking an assertive step about making the market transparent and doing something as opposed to turning the blind eye which is the historical norm (no offense). When NYSE Open Book first came out it was a nice gesture, but with the time delay it wasn't really what I would consider helpfull. Nor was limit-nx. Regulation SHO made things a little interesting.

Anyhow, little did I suspect to see what I see now.

Limit Sweeps taking a listed stock up/down 20~30 cents thereby triggering a LRP. Where, in what appears (and I stress appears for I have no factual proof) to be a thinly veiled attempt at manipulation, it appears the same floor brokers who entered the sweep are now buying/selling what they bought/sold via the spec auction market to those poor souls whose system stops were triggered. To those who place DOT orders market/limit? You are locked out; forget about it, you are not going to get those prints.

"Black Box" trading systems. Rarely before did I see a stock get taken up/down over a point with 1200 traded with hundred share bids/offers. Now its not that unusual. Block action my butt, and the dance of the 100 share bid. Now you see it now you don't! Oh wait its back...oh no its lower...oh wait its back..oh wait its higher...and on and on. It gets rather annoying don't you think?

Price improvements? Specialist algorithms? Not being used as much as hoped? Huh? Would you kindly point to an example of it happening on a regular basis? For I will be more than happy to show you otherwise, cause to be honest I haven't seen it yet. Seriously, though, what is the point of having this "system" in place if its not enforced by the NYSE? Why put on a dog and pony show?

Elsewhere on this blog you mentioned something about floor brokers and to use them. Well thats all fine and dandy, but isn't that counter intuitive? On today's blog post as well as other mentions from the NYSE, the hybrid system was due to pushing from your "biggest customers" for automatic execution. They got it right? Up to a million shares? So why is it we need a Floor broker? Where is the transparency in that? How fair is it when a floor broker works an order in the crowd without displaying it to the world? Why am I not allowed to see the equote-d, equote-reserve, squote-d, squote-reserve? Only the consolidated quote, and whatever dot limits that are shown on open book? It seems to me transparent market is given but to only a privileged few.

I mean, what the heck Sir? What are you guys doing with the fees I pay for every transaction? Can I get a rebate if I am not happy? Heck, even at Burger King they will try to make it right or refund me my money. At .00025 per share (I think I am right) and 4~6 mil traded a month, hot dang next round is on me!

At least when the specialists controlled the market you knew they were not your friend. Things like ND, or my favorite, 100 shares ahead and watch 10+k print over the course of two minutes while you sit there with a marketable limit/market order. While this was annoying, it was a silently acknowledge cost of doing business. Slippage was a fact of life. Calling in for a price complaint was a waste of time, and governor's ruling? Haha...

Now its gang rape.

by TomN on February 15, 2007 11:06 PM

"I'll be after the next big bear market, when the public and regulators and politicians scream for a new scapegoat - the cascade of electronic sell orders that "caused" the panic selling."

Maybe you didn't trade then or are not old enough to remember, but during the October 1987 crash, NYSE specialists simply walked away from their posts. Just like that...

An all-electronic system would not have done any worse, but it certainly could have done better.

by Max on February 17, 2007 3:17 PM

Tony -- Again, I don't have answers at this point. All I can say is that we're actively reviewing the results to date and will continue working to improve our market. Will keep you posted.

You and another commenter had raised again the idea of changing the minimum spread to a nickel, as a way of aggregating more liquidity at fewer price points. Yet another commenter criticized the idea. I wanted to just note that NYSE once advocated a similar point. Twice, actually.

You might recall that when some markets began quoting and trading in sixteenths instead of eighths, NYSE resisted. But the conventional wisdom was that tighter spreads would cut trading costs for investors. I guess it was harder to quantify such factors as lesser transparency, smaller trade size and the need for more transactions to accomplish the same business. When other markets went to 'teenies, NYSE could not afford to offer inferior prices, so we followed.

When the next step -- trading in 1/32s -- was broached elsewhere, we protested again. How could the investing public be expected to deal with factions of 1/32? And what would follow -- 1/64s? Again, in vain.

But before 1/32s got going, we interceded and went to decimal increments, with a penny minimum, as a way to stop the fraction madness.

Experience shows that if we had set a nickel increment, someone else would have gone 4 cents, then 3, etc. and we would have been at a penny in no time.

Which brings us to today. One market alone -- even NYSE -- could not unilaterally adopt a nickel minimum increment, without putting ourselves and our customers at a competitive disadvantage. So it would take an action of the SEC to mandate nickels. For NYSE, having lost twice on the issue, we're focusing our efforts elsewhere.

Thanks again for writing, Tony. Your advocacy of market quality is admirable.

by Ray Pellecchia on February 19, 2007 8:15 PM

Jack -- Thanks for writing. I expect that at some point in the future (and I hope it isn't a cataclysm!), you'll have another opportunity to advocate for specialists, and your sharing your perspective will again be appreciated, as it is here.

by Ray Pellecchia on February 19, 2007 8:45 PM

Max -- Specialists absolutely did not walk away from their posts in October 1987. During that crash, they actually doubled their usual percentage of buying against the trend. In many instances, they were the only buyers.

In fact, several firms bought so much stock of plummeting value they actually didn't have enough capital to resume trading the next morning, and had to be merged with larger firms before opening for business.

You might be thinking of the over-the-counter market, where dealers simply let the phone ring. They could afford to do so because they don't have the same obligation that specialists have to trade against a rapidly moving market.

by Ray Pellecchia on February 19, 2007 8:54 PM

Ray,

I am hearing that the NYSE is going to pass thru the costs of ECN's soon. If we get charged $3.00 per 1000 to cross an ARCA/INET and pay .275 for the DOT fee... NYSE will become the most expensive way to trade a stock... and volume will surely fall off.

Furthermore... the amount of program traders trying to trade for liquidity rebates will migrate to ECN's and continue to erode your market share.

The deepest liquidity pools will then be with the orders that are parked off the floor. This will make floor brokers less valuable and too costly to trade since they wont get to the deepest liquidity.


Everyone knows that when you want to get a stock instanteously... you have to go to the ECN's ... NYSE is too unreliable. I don't think a trader on this board would disagree with me on that.

Can you elaborate on the NYSE's decision on passing thru routing costs ?

Thanks,

David

by David on February 19, 2007 11:29 PM

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