Competing Business Models Liquidity Providers (Capital Commitment) None One Many Attain Archipelago B-Trade Brut Instinet Island MarketXT NexTrade REDIBook NYSE Amex Nasdaq Data as of January 2002.
Liquidity Providers What does that mean? None: Alternative Trading System (ATS), Electronic Communications Network (ECN) Electronic order-matching system No capital commitment from firm One: NYSE and Amex Specialist system Capital commitment from single firm Many: Nasdaq Dealer system Capital commitment from multiple firms
ATS/ECN Model Fully electronic, ordermatching system No intermediary No capital commitment from firm Allow for anonymity
Auction Market Model Floor-based Single Specialist Order-driven Capital commitment from one firm
Role of the Specialist Auction Markets utilize a single dealer, known as a Specialist. Match incoming buy and sell orders Trade from their own account Capital resources from one firm
Advantage of Auction-based Markets Most orders are executed at a single, centralized location Provides a chance for two investors to meet Enhanced price improvement opportunities NYSE Amex NYSE
Auction Market Order Flow Floor Broker Floor Broker Floor Broker Specialist Floor Broker Small Orders routed electronically directly to Order Book
Dealer Market Model Screen-based Competing Market Makers Quote and Order-driven Capital commitment from multiple firms Continuous order flow
Role of the Market Maker A Dealer Market uses multiple dealers, known as Market Makers. 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
Expanded Role of the Market Maker Retail Sales Institutional Sales Research Analysts Corporate Finance
Dealer Market Order Flow Competing Market Makers
Dealer Market Order Flow Immediate & continuous trading
Advantage of Screen-based Markets Allow equal access to trading and market information World s most common market structure Unlimited number of market participants No central trading floor
Nasdaq Market Structure: Spread BID ASK 30.25 30.375 Spread =.125 The spread, or difference between a stock s BID and ASK price, represents the capital risk a market participant undertakes when buying or selling a stock.
Spread Every Market Maker must register to trade a stock with both a bid and offer price. In 1997, ECNs were also included as market participants. BID PRICE POSITION TO BUY MM1.25 MM2. MM3. ECN1 MM4. ASK PRICE POSITION TO SELL 25.25...MM4.. ECN1..MM3.. MM2..MM1 Market Marker 1 has positioned itself to buy stock.
Spread All trades on Nasdaq are required to be executed at the best displayed price or better (when trade size < displayed size). BID PRICE MM1.25 MM2. MM3. ECN1 MM4. ASK PRICE 25.25...MM4.. ECN1..MM3.. MM2..MM1
Order Execution: Retail Buy Investor Retail Buy Buy 200 shares @ 25.25
Retail Buy Order Scenario 1 BID OFFER Retail Buy 25 200 MM 25.25 Retail investor wants to Buy 200 shares @ 25.25. Market Maker has 200 shares in inventory. Market Maker is currently quoting willingness to sell (offer) shares at and willingness to buy (bid) shares at.
Retail Buy Order Scenario 1 BID OFFER Retail Buy Sell 25 200 MM 25.25 Retail investor wants to Buy 200 shares @ 25.25. Market Maker matches current best offer price and fills Buy order at best offer price of 25.25. Trade Report: 200 @ 25.25
Retail Buy Order Scenario 2 Immediacy of Execution BID OFFER Retail Buy Sell 25 MM 25.25 Retail investor wants to Buy 200 shares @ 25.25. Market Maker does not have shares in inventory. Market Maker matches current best offer and sells short 200 shares at 25.25. Trade Report: 200 @ 25.25
Cover Short Position Immediacy of Execution BID OFFER 25.125 200 Retail Buy 25 MM 300 Retail Sell Retail investor bought 200 shares @ 25.25. Market Maker raises its Bid price to build inventory. This action affects other prices. Retail investor wants to Sell 300 shares.
Cover Short Position Immediacy of Execution BID OFFER 25.125 25 MM Buy 300 shares 300 Retail Sell Market Maker Buys 300 shares at its best bid price of 25.125. Retail investor Sells 300 shares to Market Maker. Trade Report: 300 @ 25.125
Institutional Buy Order BID 25.125 25 MM OFFER Institutional Investor Buy 100,000 shares at 25.25
Institutional Buy Order BID 25.125 25 MM OFFER Institutional Investor Volume discount negotiated inside the spread. Trade Report: 100,000 @ 25.25