Is clean-up pricing workable under hybrid? The New York Stock Exchange believes it has incorporated a design feature into its hybrid market proposal that will encourage limit order traders to come out of the woodwork. Those hardy souls who risk their necks and post orders on the book may get filled at prices even better than expected, according to the Big Board.
That could happen if an incoming sweep order trades against a series of limit orders posted at a range of prices. Those limit orders posted at the top of the book will fill at the market's best price. But those orders posted away from the inside may fill at the so-called "clean-up price," or the last price in the range necessary to completely fill the incoming sweep order. A limit order to buy at $25.40, for example, when the best bid is $25.50 might, in theory, fill at $25.30 if an incoming sell order sweeps down to $25.30.
At this year's TradeTech confab, two traders tackled the pros and cons of the clean-up price. John Wheeler, American Century, and Dan Mathisson, Credit Suisse, offer their views.
John Wheeler, American Century
We've always taken the exchange's price improvement mechanism with a grain of salt because it was always price improvement for the intermediaries, for the specialist, for the orders that come into the exchange. It was not necessarily price improvement for the people who are taking the risk of displaying those limit orders on the floor. We've been making that argument for 15 years. Hybrid finally acknowledges that. It gives us a structure whereby we're rewarded for posting limit orders in the book. (We would of course like to have electronic reserve access, but that they are denying us.) But if you are [on the book as a seller] with 7-cent, 8-cent, 9-cent orders [when the best offer is higher] and someone comes in and is willing to pay a dime, you will roll up to that higher price versus walking the book now. There is a big debate as to how much of this activity there will be, but there will be some willingness on the buyside to display or even hide in reserve limit orders on the NYSE book. Because, for the first time ever, as the aggressors come into the marketplace, we will be rewarded versus being compromised.
Dan Mathisson, Credit Suisse
In that example with limit orders at 7 cents, 8 cents, and 9 cents, and someone wants to trade through 10, there will be one extra step. Because of Reg NMS, after they trade the sevens, they will have to sweep the eights and the nines, whatever the top of book bids and offers are on all the ECNs and regionals first. It is a question of how much will be left to push up to ten. They can't trade at 10 until they sweep all the tops of the books up to 10. When [the NYSE] designed the hybrid they thought they would be the whole game. But over the last one-and-a-half years, we've seen the ECNs become viable. Now the regionals are looking viable. So it is going to be more complicated. And a lot of the hybrid mechanisms aren't going to work very smoothly when they have to stop and do intermarket sweep orders and then try to print. So it is questionable…. Our take on the hybrid is that it is a good place to take, but not a great place to provide liquidity. If you are taking liquidity under the price improvement rules, the specialist can jump in front of the limit order and improve the order on its way in. That makes it a nice place to take liquidity. If you're looking to lift a 26-cent offer and maybe get a fill at 24 cents, that's great. But, if you are the guy offering at 26 and the specialist steps in front of you and price improves by 2 cents, that's no good. We think we will be leaning towards just taking on the NYSE, not providing liquidity.
