Sub-Penny Pricing

Exchange officials are lobbying hard for sub-penny quoting. They say it is because their institutions and hedge funds have been asking for this ability. I doubt that. My customers have not been demanding 1/10th of a penny pricing. Have you been?

I think that this is more of the exchanges courting High Frequency interests, at the expense of traditional players (wait… The HFT guys benefit the traditional guys with all of their liquidity…. I forgot for a moment).  HFT margins have certainly been contracting, as media and government focus, and more importantly new market entrants, have squeezed their profit margins. HFT players want sub-penny pricing, not because the extra sub-penny executions would pad their margins, but rather because the sub penny pricing will allow HFT shops more ways to step in front of traditional institutional hedge and mutual fund orders.

Proponents say that this will force some dark order flow to the light. This sounds good on the surface, but as I think about it more, I believe it will force more order flow to the dark, and make our markets less transparent. Price discovery will be hurt. How likely will you wish to display your orders in the quote if there are more means (sub penny orders) for the co-located HFT players to step in front of your order and absorb liquidity (and receive exchange rebates in the process) that you were entitled to? HFT orders and cancellations travel at speeds measured in microseconds and smaller. Should we as a collective market be proud of innovation that also allows the quoting of stocks in currency units that don’t even exist in the real world? Who would such innovation really benefit?

I will give this more thought. If you have not thought about this issue, please do so and make your voices heard to your reps at the exchanges, as well as the SEC. The exchange leaders would have the SEC believe that each and every one of you have been banging down their door for them to give you this ability. I doubt this.

The appended article for your reading :


Dow Jones

NYSE Euronext and Nasdaq OMX Group are among the exchanges pushing for trading of stocks in amounts less than a penny. Above, the stock prices are displayed in the studio at the Nasdaq Marketsite in New York

It’s tenth-of-a-pennies from heaven.

The major U.S. stock exchanges are pushing regulators to allow price quotes in increments as small as a tenth-of-a cent. The changes are part of the exchanges’ push to become more attractive to electronic traders who have left their platforms for private “dark pools.”

NYSE Euronext, Nasdaq OMX Group Inc. BATS Global Markets and Direct Edge ECN LLC—an electronic platform that has yet to secure exchange status—said they are backing the initiative to revamp the stock quote. But it could take upward of a year to get the Securities and Exchange Commission’s blessing.

“We’ve had institutions, hedge funds, a broad variety of customers asking for this,” said Brian Hyndman, senior vice president of transaction services for Nasdaq OMX Group.

U.S.-listed stocks have been publicly quoted in one-cent increments since 2001, having previously been calculated in eighths of a dollar. Traders can only quote sub-penny prices on exchanges when a stock’s value dips below $1, although stocks can be delisted if they languish below this mark for too long.

This leaves the exchanges at a disadvantage to alternative venues known as dark pools, which are private trading systems increasingly used by traders. The pools are mainly controlled by banks and trading firms, though some exchanges are moving into the space.

The dark pools command a big share of overall trading for heavily traded stocks with single-digit share prices such as Citigroup Inc. “A majority of the trading in stocks like Citigroup is done off-exchange, because market makers can’t compete at a finer increment for the order,” said Chris Isaacson, chief operating officer of BATS.

While large institutional traders are driving the push, exchange officials said expanding sub-penny pricing on their platforms could also improve conditions for individual investors. Recovering some of the exchange liquidity lost to dark pools will help tighten price spreads, they said.

The push comes after the SEC earlier this month asked exchanges to explore the issue as part of a broader look into dark pools and high-frequency trading firms.

Exchange executives have raised concerns as more stock-trading activity has moved away from public markets in recent years. They have cautioned that the public prices of stocks could become less reliable as more trading migrates to alternative venues.

Rosenblatt Securities estimated that the 16 largest dark pool platforms, most of them controlled by dealer-brokers, accounted for a record 9.7% of all U.S. stock volume in November 2009.

The exchanges have yet to reach a consensus on the best increments for trading if the SEC accedes to a change. NYSE Euronext and Nasdaq OMX officials favor 0.1-cent increments, while BATS is leaning toward half pennies, executives said.

Steve Sosnick, equity risk manager at Timber Hill, a market-making unit of Interactive Brokers Group Inc., said the push isn’t a surprise given recent trends. “Everybody’s trying to come up with advantages, and a lot of incremental advantages are getting ever smaller.”

Some stocks could see pricing increments move the other way. Bryan Harkins, head of sales and strategy for Direct Edge, said that while his company supports the idea of sub-penny pricing, it may also be worth considering bigger increments in higher-priced, less-liquid stocks as a way to improve liquidity.

“People need to be thinking about whether the penny is the right increment for trading in all circumstances, or is that a one-size-fits all approach that under-serves issuers and investors at times?” said William O’Brien, chief executive of Direct Edge.

—Donna Kardos Yesalavich contributed to this article