©r. schwartz equity markets: trading and structureslide 1 topic 6
TRANSCRIPT
Slide 1 ©R. Schwartz Equity Markets: Trading and Structure
Topic 6
Slide 2 ©R. Schwartz Equity Markets: Trading and Structure
How Buyers & SellersMeet Each Other
Slide 3 ©R. Schwartz Equity Markets: Trading and Structure
ECONOMICS 101
PRICE
SELL
QUANTITY
BUY
Q*
P*
0
The perfectly liquid, frictionless market solution
The closest thing to it is a Call AuctionThe closest thing to it is a Call Auction
Slide 4 ©R. Schwartz Equity Markets: Trading and Structure
The Big Problem
Enabling Buyers and Sellers, Large and Small, to Find Each Other
Two Dimensions
• Place
• Time
Slide 5 ©R. Schwartz Equity Markets: Trading and Structure
10:50 10:55 11:00
PublicBuyer
PublicSeller
LimitOrder
Executes
Placesa BuyLimit
Order
Order Driven Market
The limit order book brings
buyer& seller together
The limit order book brings
buyer& seller together
Slide 6 ©R. Schwartz Equity Markets: Trading and Structure
10:50 10:55 11:00
PublicBuyer
PublicSeller
DealerBuys
DealerSells
Dealer Intermediation
Dealer provisionof immediacybrings buyer
& seller together
Slide 7 ©R. Schwartz Equity Markets: Trading and Structure
10:50 10:55 11:00
PublicBuyer
PublicSeller
A Call Auction
A meeting pointin time can bring multiple buyers &
sellers together
Slide 8 ©R. Schwartz Equity Markets: Trading and Structure
How a Call Auction Works
Slide 9 ©R. Schwartz Equity Markets: Trading and Structure
The Electronic Call Auction
• Orders that could otherwise be matched and executed are held for a big, multilateral clearing
• Clearings are held at pre-determined points in time (i.e., once an hour)
• All crossing orders are executed at a single price
– Buy orders at that price and higher execute
– Sell orders at that price and lower execute
Slide 10 ©R. Schwartz Equity Markets: Trading and Structure
O
The Batching of Customer Orders
••
O
•
•O
• O•
O
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Question
How should these limit ordersbe integrated to produce a good
price?
1 2 3 4 5 6 No. Orders
PriceO Offer• Bid
Slide 11 ©R. Schwartz Equity Markets: Trading and Structure
Cumulate The Buy Orders
• (1)
• (3+1=4)
• (4+1+5)
• (5+1=6)
••
•
•
•
•51
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1 2 3 4 5 6 No. Orders
Price
• (1+2=3)
• Individual buy order
Cumulated buy orders at the price or better
Slide 12 ©R. Schwartz Equity Markets: Trading and Structure
Cumulate The Sell Orders
•
•
•
•
•
O(1)
O(2)
O(3)
O(4)
O(5)
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1 2 3 4 5 6 Orders
Price
• Individual sell orderO Cumulative sell orders at the price or better
Slide 13 ©R. Schwartz Equity Markets: Trading and Structure
Match Cumulated Buy & Sell Orders
O
O
O
O
O
CUMULATED SELL ORDERS
•
•
••
• CUMULATED BUY ORDERS
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1 2 3 4 5 6 Orders
Price
3
50P* =
Slide 14 ©R. Schwartz Equity Markets: Trading and Structure
Call Auction Limit Order Books
Sparser Book
Thicker Book
Slide 15 ©R. Schwartz Equity Markets: Trading and Structure
When Calls Are Used
• Market Openings• Market Closings (MOC & LOC orders)• Nasdaq’s Crosses (open and close)• Intra-day At a predetermined time To reopen the market after a trading
halt
Slide 16 ©R. Schwartz Equity Markets: Trading and Structure
Calls Auctions And…
• Electronic technology• The time clock – Jim Ross’s piece in the text• Who gets price improvement – Al Berkeley’s piece in the text
Slide 17 ©R. Schwartz Equity Markets: Trading and Structure
Benefits
• Focused liquidity – especially small & mid caps
• Control price volatility • Fair• Harder to manipulate• Lower order handling costs• A price discovery mechanism
Slide 18 ©R. Schwartz Equity Markets: Trading and Structure
Problems
• Does not offer immediacy• Bookbuilding
Slide 19 ©R. Schwartz Equity Markets: Trading and Structure
Order Handling DifferencesCall vs Continuous Trading
• Market orders – infinitely aggressively priced limit orders• Limit orders – can expect to be price improved
Who provides liquidity to whom in a call?
Slide 20 ©R. Schwartz Equity Markets: Trading and Structure
Types of Calls
• Price Scan Auction• Sealed Bid Auction• Crossing Network• Open Limit Order Book Auction – TraderEx
Slide 21 ©R. Schwartz Equity Markets: Trading and Structure
Optimal Order Placement
Slide 22 ©R. Schwartz Equity Markets: Trading and Structure
How to Submit a Buy Order: Calls are the only game in town
Your Reservation Price = $12Your Reservation Price = $12 Limit Price Clearing Price Surplus $11.10 $11.20 $0.00 $11.10 $11.10 $0.90 $11.10 $11.00 $1.00
Limit Price Clearing Price Surplus $11.20 $11.30 $0.00 $11.20 $11.20 $0.80 $11.20 $11.10 $0.90
Why not $11.30 or higher?
Slide 23 ©R. Schwartz Equity Markets: Trading and Structure
How to Submit a Buy Order: Calls are the only game in town
Your Reservation Price = $12Your Reservation Price = $12
Conclusion
Limit Order Price = Reservation Price = $12
(Or one tick below)
Slide 24 ©R. Schwartz Equity Markets: Trading and Structure
How To Submit A Buy Order To ACall That Is Followed By
Continuous Trading
Your Reservation Price = $12Your Reservation Price = $12
Question: Would You Prefer To
1.Execute at $12.00 or not at all?
2 Execute at $11.90 in call or at $11.90 in continuous with 0.99 prob?
3. Execute at $11.90 in call or at $11.80 in continuous with 0.90 prob?
4. Execute at $11.90 in call or at $11.80 in continuous with 0.10 prob?
5. Execute at $11.90 in call or at $11.80 in continuous with 0.50 prob?
Slide 25 ©R. Schwartz Equity Markets: Trading and Structure
How to Submit a Buy Order: Call Followed by Continuous
(Answers to Questions 2 – 4)(Answers to Questions 2 – 4)
= $0.20 x 0.50 = $0.100
Expected Surplus at $11.80
=Surplus at $11.90 = $0.100
Q5
= $0.20 x 0.10 = $0.020
Expected Surplus at $11.80
>Surplus at $11.90 = $0.100
Q4
= $0.20 x 0.90 = $0.180
Expected Surplus at $11.80
<Surplus at $11.90 = $0.100
Q3
= $0.10 x 0.99 = $0.099
Expected Surplus at $11.90
>Surplus at $11.90 = $0.100
Q2
Continuous AuctionCall Auction
Slide 26 ©R. Schwartz Equity Markets: Trading and Structure
How to Submit a Buy Order: Call Followed by Continuous
0.80$0.50$0.40$11.50$11.60
0.75$0.40$0.30$11.60$11.70
0.67$0.30$0.20 $11.70$11.80
0.50$0.20$0.10$11.80$11.90
NA$0.10$0.00$11.90$12.00
ContinuousCall
Breakeven Probability
of Executing in
Continuous
Surplus in Continuous
Surplus in Call
Price
Finding the Optimal PriceFinding the Optimal Price
Slide 27 ©R. Schwartz Equity Markets: Trading and Structure
How to Submit a Buy Order:Continuous Followed by Call
Your Reservation Price = $12Your Reservation Price = $12
• Your time frame is the trading day
• You place a day order that must be filled by 4:00 pm
• As the day progresses, all else equal, you are more apt to place a market order than a limit order
• There is a closing call
• Your limit order in the closing call would be one tick below your reservation price ($12)
Slide 28 ©R. Schwartz Equity Markets: Trading and Structure
Continuous Followed by Call
• E(S) = [Pr x SCont] + [(1-Pr) x E(SCall)]• SCont = surplus if order executes in cont. market • E(SCall) = expected surplus from the call• SCall = max(0, PR – PCall)• Because (1-Pr) x E(SCall) >0, you are more apt to place a limit order in the continuous market when it is followed by a closing call• Remember the gravitation pull effect
S = your surplus from tradingPr = prob your limit order executes in cont. market
Slide 29 ©R. Schwartz Equity Markets: Trading and Structure
A Call’s Contribution to Market Quality
Slide 30 ©R. Schwartz Equity Markets: Trading and Structure
Let’s Focus on Volatility
• The opening spike: Price discovery
• The closing spike: End of day impatience to Get the job done
• What does this imply about market structure?
• A natural experiment: Nasdaq’s closing/opening crosses (call auctions) introduced in March/October of 2004
Slide 31 ©R. Schwartz Equity Markets: Trading and Structure
The Nasdaq Study*
• 52 large cap Nasdaq firms
• Time period: Feb 04 and Feb 05
• We examined per day:
390 1-minute intervals (9:30-16:00)
30 10-second opening intervals (9:30-9:35)
30 10-second closing intervals (15:55-16:00)
• Volatility measured by high-low range for the interval
**“Market Structure and Intra-day Price Volatility:“Market Structure and Intra-day Price Volatility:An Event Study on Nasdaq’s Crosses”An Event Study on Nasdaq’s Crosses”
Michael Pagano, Lin Peng, and Robert SchwartzMichael Pagano, Lin Peng, and Robert Schwartz
Slide 32 ©R. Schwartz Equity Markets: Trading and Structure
Nasdaq Volatility Differences BetweenFeb 2004 and Feb 2005One-minute Volatility
wr ange
0
20
40
60
i nt er val
0 30 60 90 120 150 180 210 240 270 300 330 360 390
60 bps60 bps Feb 2004 (Pre-Calls) Feb 2004 (Pre-Calls)r ange
0
20
40
60
i nt er val
0 30 60 90 120 150 180 210 240 270 300 330 360 390
60 bps60 bps Feb 2005 (Post-Calls) Feb 2005 (Post-Calls)
Slide 33 ©R. Schwartz Equity Markets: Trading and Structure
r ange
0
10
20
30
40
i nt er val
0 6 12 18 24 30 36 42 48 54 60
Nasdaq Volatility Differences Between
Feb 2004 And Feb 200510-Second Volatility
r ange
0
10
20
30
40
i nt er val
0 6 12 18 24 30 36 42 48 54 60
40 bps40 bps Feb 2004 (Pre-Calls) Feb 2004 (Pre-Calls)5 Min After
Opening5 Min Before
Close
40 bps40 bps Feb 2005 (Post-Calls) Feb 2005 (Post-Calls)5 Min After
Opening5 Min Before
Close