Cover Sidebar: Nasdaq Experiments With Price/Size

Nasdaq plans to start a third stock exchange later this year using the license it got with its acquisition of the Philadelphia Stock Exchange. If approved by the Securities and Exchange Commission, the new exchange, to be called Nasdaq OMX PHLX, will substitute the traditional price-time priority model with one based on price and size.


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Today, all stock exchanges and ECNs, except the New York, adhere to strict price and time priority. That means first come, first served. Under the rules of Nasdaq’s soon-to-be proposed PHLX market, first come may have to share with later arrivals. Price-and-time priority means the first trader offering the best price gets 100 percent or however much he wants of the first incoming contra-side order. The PHLX price-and-size priority model means the first trader may end up sharing that incoming contra-side order with others. His allotment will be based on how much he is quoting. The bigger his quote, the bigger his cut.

For example, assume six orders posted in succession at the market’s best price. First, five 100-share bids came in. Then, a single 500-share bid posted. So now there is a total 1,000 shares on the bid. If a 1,000-share sell order were to hit the PHLX, the trader with the 500-share bid would get half of the order, despite the fact that he posted last. The five other bidders would each get 10 percent of the sell order.

The concept underlying the proposed PHLX is not new. In the options industry, for instance, on traditional exchanges, market makers are entitled to receive up to 40 percent of an incoming order, depending on the size of their quote. Under the Nasdaq scheme, market makers are likely to be the initial suppliers of liquidity to the PHLX, Noll noted.

By guaranteeing traders a bigger share of any incoming order, Nasdaq hopes to recapture some of the large trades that have been lost to dark pools and the upstairs market in general. "We want to address the perception–if not the reality–that you can’t get large size done in the transparent markets because there is too much market impact," said Eric Noll, executive vice president of transaction services for Nasdaq OMX. 


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