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June 1, 2011

Brokers Field Less Citi Volume

By John D'Antona Jr

Stock splits are often good for investors, but the recent Citi reverse split won't be good for traders.

As a result of Citi undergoing a 10-to-1 reverse split on May 9, traders---particularly on the floor of the New York Stock Exchange---are seeing a major downturn in trading volume and profit opportunity. Average daily volume has gone from roughly 480 million shares before the reversal to around 40 million afterward. A substantial reduction in volume, to be sure, but closely in line with the 10-to-1 ratio of the Citi reversal.

Keith Bliss, Cuttone & Co.

The dynamics of turning a $4.50 stock into a $45 stock raise the risk profile of trading Citi, which once accounted for roughly 6 percent of the U.S. market's total volume. The float went from 29 billion shares on May 6, to 2.9 billion shares the following Monday. Citi closed that day at $44.16 per share, compared with its previous close of $4.52.

Floor traders on the NYSE previously traded tons of Citi shares daily because they benefited from "the parity trade," which gave the clients of floor brokers a distinct advantage.

In other words, the NYSE does not follow a time-priority model for order handling, as most electronic marts do. Instead, the NYSE has parity and a priority rule. That means the first order in gets priority. But the second, third, fourth and so on must share incoming fills with each other-that is parity. Under a time-priority model, competition is stiff because a trader must be very fast to get to the head of the line to capture order flow.

At the NYSE, whoever sets the best price first gets filled first. But that fill may be for only 100 shares, and at the New York, time priority is good for only one trade. If the first man is bidding for 1,000 shares and a 100-share sell order comes in, that's all his priority gets him. Any subsequent incoming sell orders are shared with the pack.

The parity concept at NYSE has been good news for the floor brokers because they are the only ones who get parity. Now that Citi has fewer shares and is higher-priced, they are likely to see that business, which was substantial for some firms, evaporate.

"At the end of the day, if the exchange is losing volume, then not only is the exchange losing revenue, but so are the floor guys," one senior floor broker said.

Citi stock is traded more frequently than any other on a per-day basis, according to a study last month by Rosenblatt Securities. Citi contributed 5.7 percent of total U.S. equity volume in April, the study said.

Based on 2010 data from Rosenblatt, the reverse split could mean a loss of 1.8 billion in share volume per month for Nasdaq OMX and 3.4 billion for NYSE. This translates roughly into a quarterly revenue loss of about $3.7 million for the New York and $1.4 million for Nasdaq. And that's no small potatoes in this environment.

Rosenblatt wrote that, "Post-split, exchanges should gain market share in Citi, but still be net losers with respect to volume and transaction revenue because the pie will be dramatically smaller."

Keith Bliss, senior vice president and director of sales and marketing at Cuttone & Co., said that while the Citi parity trade will likely fade, others could emerge.

"With the reverse split, I think the parity trade will go away in Citi," Bliss said. "Volumes in Citi will shrink. The inherent risk of trading 500 shares of Citi at $45 is a lot different than at $4.50."

But he added: "My guess is that firms who have built trading regimes around this type of trade will be moving into another parity trade. It's unlikely these guys will stop using this trading style."