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Why Would An Exchange Create An Order Type Designed NOT to Trade?

25

July, 2012

We thought that stock exchanges were in the business of matching buyers and sellers.  It’s a fairly simple process – place a bid on an exchange, seller sees it, seller hits the bid and trade is executed.  Well, we all know by now that this is not exactly how the stock market works anymore.  Exchanges and dark pools have figured out ways to circumvent this simple process so that the their highest volume clients can step in between and siphon off some risk free profits.  Today, we would like to talk about yet another new order type that has been designed with the intention of NOT to trade.

We present to you the NYSE Arca PL Select Order type.  Before we tell you what this is, we want to let you know that the SEC has not yet approved this order type.  NYSE Arca submitted their proposal  to the SEC on June 4, 2012 but the SEC decided to extend their normal 45 day approval process for another 45 days, even though there were no comments filed on this proposal.  Why would the SEC not just rubber stamp this order type?  After all, there are so many different order types nowadays on exchanges, what harm could one more do?

The NYSE Arca PL Select Order is defined as:

“a PL Order that would not interact with an incoming order that: (i) has an immediate-or-cancel (IOC) time in force condition, (ii) is an ISO,or (iii) is larger than the size of the PL Select Order. “

This order type has been designed to only trade against certain type of order flow.  It won’t trade against IOC or ISO orders and it won’t trade against orders that are bigger than itself.  You could say that this order is very discriminatory.  Here is what NYSE Arca says about this order type;

“As proposed, except for the specified restrictions on trading with certain incoming orders, the PL Select Order would otherwise operate as a PL order and would retain its standing in execution priority among PL Orders. The Exchange notes, however, that for those instances when an incoming order meets one of the PL Select Order restrictions, the PL Select Order would be skipped and can be traded through.”

Read the last part of that statement again.  The PL Select Order is designed to be traded though.  How is this not a direct violation of the Reg NMS Rule 611 (aka, the Order Protection Rule)?  Rule 611 states:

Rule 611(a)(1) requires a trading center (which includes national securities exchanges, exchange specialists, ATSs, OTC market makers, and block positioners)52 to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs on that trading center of protected quotations and if relying on an exception, that are reasonably designed to assure compliance with the terms of the exception.”

A key provision of Reg NMS was forcing all orders to interact with the best bid or offer and not allowing orders to be traded through.  NYSE Arca is essentially asking the SEC to throw this rule out the window.  They want their own orders to be traded through.  NYSE Arca gave this example in their filing on how a PL Select Order would work:

For example, assume that the protected best bid and offer is $19.00 – $19.50 and a User enters a PL Select Order to buy 5,000 at $19.25 (B1). A second User enters an order to buy 1,000 at $19.00 (B2). If an incoming ISO sell order at $19.00 for 500 shares arrives (S1), S1 would not trade with B1, and would instead trade with B2 for 500 shares at $19.00. Because B1 is a PL Select Order, and is restricted from trading with an ISO, it would be skipped. If another sell order at $19.00 for 700 shares arrives (S2), and it is not marked IOC or ISO, S2 would execute against B1, 700 shares at $19.25. In this situation, because S2 does not meet any of the restrictions of the PL Select Order, B1, which arrived before B2, would receive the entire execution.”

It is just absolutely mind boggling why the exchanges continue to complicate the very simple process of buying and selling a stock.

 

One Response to “Why Would An Exchange Create An Order Type Designed NOT to Trade?”

  1. Jamie Selway
    avatar

    Sounds like a second cousin to an MAQ order. They trade through, too.


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