Commentary

Jared Dillian
Traders Magazine Online News

Was it Worth It?

In this piece from 10th Man, author Jared Dillian discusses how the ETF revolution is less about ETFs and more about indexing; about how people have come to view stocks less as stocks and more as blobs of stocks.

Traders Poll

Would you feel better if the Chicago Stock Exchange were purchased by U.S. firm or consortium rather than a foreign one?

Yes

73%

No

4%

Doesn't matter to me

23%

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October 4, 2007

Adaptive Trading

By Michael Scotti

Wall Street's creativity and ability to adapt never cease to amaze. That also goes for public marketplaces, like exchanges and ECNs, which are now refining dark pool strategies. NYSE Arca, Nasdaq, ISE Stock Exchange, LavaFlow ECN and Direct Edge ECN have new plans in this area, and you can read about them on Page 40.

One strategy includes dark orders, which are non-displayed orders on the book that price-improve incoming orders. The "dark" discussion has centered on themes like consolidation, connectivity and how much of the marketplace can go undisplayed without impacting price discovery. Here's another chapter in the evolution of dark pools.

Initially, many believed that Reg NMS would spur investors to increase their use of limit orders. But what is the incentive to do so, if someone can price-improve them when they are the best bid or offer? Dark orders do that. Well, traders adapt, and they go dark, too. One trading executive said of today's market, "It's a new world…transparency is a thing of the past." True, but the past also haunts us. Didn't limit orders used to get the same "price improvement" treatment on the NYSE floor, as incoming orders got exposed to the crowd? Now it is just being done electronically, and there is no outcry-like before-from institutions or others. The complaint was that it was their limit order that attracted the incoming order, yet they didn't get a fill. Traders have adapted, however.

The benefits of electronic trading and dark pools are undeniable-cheaper commissions, greater anonymity, less market impact. But there has been one downside for the pension fund/plan sponsor community: ticket charges from their custodians. Our clearing guru Gregory Bresiger describes the problem and some possible solutions this month.

There's a bit of an ironic twist to this story, if you think about it. Brokers go to great lengths to avoid exchange fees and execute in the dark; but the more places an order gets executed, the higher the cumulative ticket charges. I expect that this will be fixed.

Lastly, our options coverage continues this month with staffer Nina Mehta revisiting the maker-taker model. The upstart exchanges are experimenting with a model that has worked well in the equities world. It should come as no surprise that two of the three exchanges going this route have their roots in equities-NYSE Arca and Nasdaq. The Boston Options Exchange recently moved to maker-taker (paying those who post limit orders). How the standard bearers in the options industry-they offer a market-maker model-react remains to be seen. But like the slogan in that old cigarette commercial, I'm sure they'd "rather fight than switch."

Michael Scotti

Editorial Director