The Game of Telephone: Stock Exchange Style

Remember playing the game of Telephone when you were a kid.  One person starts with a word or a phrase and whispers it in the ear of the person next to them.  The next person does the same thing and this continues around the circle until finally the last person shouts out loud what the phrase is.  Usually, the phrase has changed into something not even close to the original phrase.  In an effort to keep market share and appease their largest clients, exchanges have been playing their own game of Telephone lately.

Their game starts with the original word of “Order” (a basic order to buy or sell a stock).  As the term “order” gets passed around the circle, it starts getting
adjectives attached to it.  Words like “mid-point” and “post-only” somehow get attached.  Finally, when the last person gets the phrase, they stand up and shout  “Mid-Point Peg Post-Only Order“.  What?  What the heck is that?  That is totally different from the original “order” word.  Thank goodness this is only a game of Telephone and not a real functionality of an exchange.  We wish that were true, but sadly, this is a new order type that NASDAQ has just gotten approved by the SEC and will go live by the end of June.

To understand what a “Mid-Point Peg Post-Only Order” is, we have to break it down into pieces.  “Mid-point” is simple enough, it’s the middle of the quoted spread.  “Peg” means it floats with the market.  But what is “Post Only”? Post-Only is an order function that some exchanges added a while back to help their liquidity rebate seeking clients.  NASDAQ describes “post only” as: “If, upon entry, the order would lock an order on the NASDAQ book, it will post at one minimum price variation away from the other side of the market.” Read more here It appears that the reason for this order is so that firms posting the order do not take any liquidity and therefore do not get charged a liquidity take fee.  So, even though they enter an order at a specific price, it’s not like they actually want to trade at that price.

Let’s add this all together and now we can understand the new NASADQ Mid-Point Peg Post-Only Order.  NASDAQ describes it as this: Read More Here

“Mid-Point Peg Post-Only is a new order type that combines elements of the existing Mid-Point Peg and Post-Only order types. Like a regular Mid-Point Peg Order, a Mid-Point Peg Post-Only Order is a non-displayed order that is priced at the mid-point between the NBBO. However, like a Post-Only Order, the Mid-Point Peg Post-Only Order does not remove liquidity from the System upon entry if it would lock an order on the book. Rather, the Mid-Point Peg Post-Only Order will post and lock the pre-existing order, remaining non-displayed”

What???  We think our brains may have just overloaded.  Why would an exchange offer an order type that would not match up with an existing order on their book?  Do they not want the volume?  Aren’t they in the business of transactions? Wasn’t one of the goals of Reg NMS to display liquidity in the quote? Of course, we all know the answer to these questions.  Most new order types and new functionality at the exchanges are driven by their top tier, high frequency
clients.  These clients want a way to gain an edge and they continue to request these ridiculous types of enhancements that do nothing to help displayed liquidity.  And rather than saying “no” to them, the exchanges just give in because they know if they don’t do what is requested, then their top-tier, high frequency clients may just pack up and go to the exchange down the street.