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February 1, 2003

Chicago's MAX Gets an Overhaul

By Peter Chapman

Also in this article

  • Chicago's MAX Gets an Overhaul

Responding to Machine Gun Trading and Customer Abuse

The Chicago Stock Exchange, hoping to help specialists deal with abusive customers and difficult trading partners, plans to rejigger its automatic execution system.

The Midwest Automated Execution System, or MAX, interfaces with the order routing systems of the Chicago mart's brokerage customers, automatically executing or delivering orders to the exchange's specialists.

Since the introduction of penny pricing, customers are hitting MAX with multiple orders at rapid-fire speed. Specialists, who must assume more risk, are also suffering other strains in conducting business.

Now the Chicago mart wants the approval of the SEC to change MAX, a system which has played a major role in the success of the CHX over the past 20 years because of its fast executions.

The proposed rejiggering is the latest in a series of changes instituted in the wake of penny ticks. It also reflects the plan by the American Stock Exchange to trade Nasdaq stocks.

The changeover to trading stocks in increments of one cent from 6.25 cents, started in 2001, has resulted in a decrease in liquidity available at the market's best prices, or the best bid and offer. With 100 price points available at which to quote, traders frequently post one cent, two cents, three cents, etc. away from the NBBO.

Despite this fanning out of liquidity the CHX, through MAX, still offers automatic executions at the ITS BBO for listed shares and the NBBO for Nasdaq shares.

That has led to abuse of MAX by some of the Chicago's brokerage customers, according to CHX sources.

To ensure their trades are done at the market's best prices, they are shooting multiple orders, rapid-fire, one after another, to MAX for automatic execution. Often the combined size of the orders exceeds the total size available at the inside.

The practice ensures the order-delivery firm executes its customers' orders at the best possible price. However, it also saddles the specialist with increased risk.

The specialist trades more shares than he would like, leaving him with uncomfortably large positions. His layoff is likely to be unprofitable as he faces the same dearth of liquidity at the inside as the originating broker.

The Chicago says the problem of machine-gunned orders is not yet a big one, but it is taking precautions.

"The problem has become a larger issue since decimalization," said Paul O'Kelly, president of the CHX. "There is less available at the NBBO."

The pending revisions to its rules have been bouncing back and forth between the CHX and the SEC since last July. If approved, they would give the specialist the latitude to cap the aggregate number of shares that he grants automatic executions.

Share caps are not new at the CHX. The specialist already sets limits on the number of shares per order that are eligible for automatic executions. This "Automatic-Execution Threshold" is typically about 599 shares regardless of the quantity available at the NBBO, according to the CHX.

The specialist also caps the total number of shares per order he is willing to execute in any capacity - either automatically or manually. This "Auto-Acceptance Threshold" is typically about 1,099 shares as long as the order size does not exceed the quantity available at the NBBO.

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