One item we have uncovered is an exception of Rule 611 contained in
Reg NMS. We believe this may hold another key in how the rapid firing
of quotes can give an advantage.
To understand how one could exploit this exception, consider how the exchanges
track their own internal NBBO:
The exchanges don't use CQS for routing. This means they receive their
information from direct links to other exchanges to compute the NBBO internally
and route based on that. In other words, each exchange is recreating what CQS
does. Due to the flickering quote exception, an exchange can ignore quotes from
another exchange that are changing more than once per second.
Because an exchange can ignore flickering quotes, you have no idea how the
quotes are factored into the exchanges internal NBBO and therefore, no idea
where the order will be routed to.
CQS does not take the flickering quote exception into consideration -- CQS
allows the quotes to set the NBBO.
If an entity broadcasts quotes rapidly that flicker the price and it is known
these quotes will be ignored by an exchange but be broadcast to the public over
CQS (and shown as the current NBBO), the entity may then have an
advantage.
To better understand this, we have created an application that reads historical
data and produces a movie of how exchange routing works. The video below shows
routing of GE orders on 05/06/2010:
Is this strategy being employed? We don't know. What we know is that it
could be and in fact the concern was raised in Reg NMS:
Page 102:One commenter opposed the exception because it believed that
it would create an arbitrage opportunity that could be taken advantage of by
computerized market participants. Another commenter expressed concern that
the exception would enable trading centers to execute trades internally and
route orders using the worst quotation during the one second window.
We leave it to the regulatory agencies to determine if indeed market
participants are taking advantage of this exception. It certainly would explain
a few of the rapid fire price/cycling high rate quote burst we see on a daily
basis and present on our "Crop Circle of the
Day" page.
This report and all material shown on this
website is published by Nanex, LLC and may not be reproduced, disseminated, or
distributed, in part or in whole, by any means, outside of the recipient's
organization without express written authorization from Nanex. It is a
violation of federal copyright law to reproduce all or part of this publication
or its contents by any means. This material does not constitute a solicitation
for the purchase or sale of any securities or investments. The opinions
expressed herein are based on publicly available information and are considered
reliable. However, Nanex makes NO WARRANTIES OR REPRESENTATIONS OF ANY SORT
with respect to this report. Any person using this material does so solely at
their own risk and Nanex and/or its employees shall be under no liability
whatsoever in any respect thereof.
