ranked from simpler to more complex/stringent
- UK — MiFID, brexit
- Asia such as Korea, Jap, HK. Each country has strict regulations such as reporting and restrictions.
ranked from simpler to more complex/stringent
https://www.investopedia.com/terms/f/fractionalshare.asp explains that fractional shares can be naturally-occurring, but I want to talk about artificial fractional shares in “normal” stocks.
Custom baskets are traded as equity-swaps. Client specify a weightage profile of the basket like x% IBM + y% AAPL + z% GE where x+y+z ==100. The sell-side dealer (not a broker) would hold the positions on its own book, but on behalf of clients.
Such a basket is not listed on any exchange (unlike ETFs). If client were to go long such a basket directly, due to limited liquidity on some constituent stocks she may not get the desired weightage. In contrast, a sell-side has more liquidity access including smart-order-routers and internal execution.
The weightage means some stocks will have fractional quantities in a given basket. Also such a basket could be too big in dollar amount like $58,476, so the sell-side often use a divisor (like 584) to create a unit price of $100, similar to a share’s price in a mutual fund. Fractional quantities are even more inevitable in one unit or in 391 units.
After a client buys 391 units she could sell partially.
With mutual funds, I often buy fractional units as well, like 391.52 units.
In an ibank equity trading system, every (partial or full) fill seems to be booked twice
I think this is because the ibank, not the client, is a member of the exchange, even though the client is typically a big buy-side like a hedge fund or asset manager.
The booking system must be reconciled with the exchange. The exchange’s booking only shows the ibank as the counterparty (the opposite counterparty is the exchange itself.) Therefore the ibank must record one trade as “ibank vs exchange”
That means the “ibank vs client” trade has to be booked separately.
Q: how about bonds?
A: I believe the ibank is a dealer rather than a broker. Using internal inventory, the ibank can execute a trade against client, without a corresponding trade on ECN.
Q: how about forex?
A: I think there’s less standardization here. No forex ECN “takes the opposite side of every single trade” as exchanges do. Forex is typically a dealer’s market, similar to bonds. However for spot FX, dealers usually maintain low inventory and executes an ECN trade for every client trade. Biggest FX dealers are banks with huge inventory, but still relative small compared to the daily trade volume.
I now believe there are at least two purposes, not necessarily reflected in any systems I worked on.
I agree that FICC products are more complex, even if we exclude derivatives
I see some complexities (mostly) specific to equities. Disclaimer — I have only a short few years of experience in this space. Some of the complexities here may not be complex in many systems but may be artificially, unnecessarily complex in one specific system. Your mileage may vary.
In derivatives, FICC etc.. risk usually refers to sensitivity to some observable factor like 10Y yield.
In delta-one context, risk often means unhedged exposure to a particular stock.
A client can ask a broker to buy “two IBM, one MSFT” either as a AA) custom basket or a BB) portfolio. The broker handles the two differently.
Only the Basket (not the portfolio) is “listed” on Bloomberg (but not on any exchanges). Client can see the pricing details in Bloomberg terminal, with a unique basket identifier.
Booking — the basket trade is recorded as a single indivisible position; whereas the portfolio trade gets booked as individual positions. Client can only sell the entire basket; whereas the portfolio client can sell individual component stocks.
Fees — There is only one brokerage fee for the basket, but 5 for a portfolio of 5 stocks.
The broker or investment advisor often has a “view” and advice on a given basket.
Corporate actions should be handled in the basket automatically.
I feel portfolio is more flexible, more informal than custom basket which is less formalized, less regulated than an index-tracking ETF.
Q1: why would anyone want to enter a swap contract on an option/futures (such a complex structure) rather than trading the option/futures directly?
Q2: why would anyone want to use swap on an offshore stock rather than trading it directly?
Q3: why would anyone want to use swap on domestic stock?
A1: I believe one important motivation is restrictions/regulation. A trading shop needs a lot of approvals, licenses, capital, disclosures … to trade on a given futures/options exchange. I guess there might be disclosure and statuary reporting requirements. If the shop can’t or doesn’t want to bother with the regulations, they can achieve the same exposure via a swap contract.
This is esp. relevant in cross-border trading. Many regulators restrict access by offshore traders, as a way to protect the local market and local investors.
A3: One possible reason is transparency, disclosure and reporting. I guess many shops don’t want to disclose their positions in, say, AAPL. The swap contract can help them conceal their position.
I now feel an equity swap is an OTC contract; whereas an IBM cash buy/sell is executed on the exchange.
I think a cash trade is like buying a house. Your ownership is registered with the government. You an transfer the ownership easily.
In contrast, if you own a share in coop or a REIT or a real-estate private equity, you have a contract with a company as the counterparty.
Before a dealer accepts you as a swap trading partner, you must be a major company to qualify to be counterparty of a binding contract. A retail investor won’t qualify.
The market maker (a dealer) does mostly prop trading, with very light client flow.
Q1: creation/redemption of units?
A: yes the ETF market maker participates in those. When the dealer has bought lots of underlier stocks, it would create units; when the dealer has bought a large inventory of units, it would redeem them (convert to underliers)
Q1b: what’s the motivation for dealer to do that?
A: there’s profit to be made
Q3: restrictions on short position held by a dealer?
A: there are restrictions on how long you can hold a short position without a borrow (stock loan). For regular investors it could be a few days or within 0 sec. For a market maker, it is definitely longer, like 5 days
Q3b: how about size of the short position?
A: probably not. However, if a dealer has a huge short position and looking for a borrow, the stock loan could be very expensive.
Q: how is the bid or ask price decided in the market maker system? Is it similar to the citi muni system? In a competitive, highly liquid market, demand is sensitive to price.
A: fairly simple because the underliers’ bid/ask are well-known and tight. For a bond ETF, the spread is bigger.
A: inventory level in the dealer’s account is another factor
A: pressure in the market micro-structure is another factor. If you see heavy bidding and few offers, then you may predict price rise
Russell rebalance day is the most hectic day of the year.
I don’t have an explanation for the increased activity. I can only guess.
Trade bust is rare on real exchanges, usually for some extreme scenarios.
It’s more common in a equity swap dealer system than an agency broker system. Assuming a buy, there are two transactions:
After a swap trade is executed i.e. after the hedge order has been executed on nyse, the dealer can bust the client leg. So for the time being there’s only the hedge position on the dealer’s book — risky. Now dealer will execute another client leg transaction at a new price.
Monitor the index (say spx) value now and 12M later. If that return is, say, 22%, then I pay you 22% of notional, on that future date.
Today, however, you pay me a fixed x% of the notional.
So the contract always references some index.
Most common Alt Trading Service is the dark pool, often operated by a sell-side bank (GS, Normura etc).
A “transparent” exchange (my own lingo) provides the important task of _price_discovery_. A dark pool doesn’t. It receives the price from the exchanges and executes trades at the mid-quote.
Market order can’t specify a price. You can think of a market buy order as a marketable limit order with price = infinity. Therefore, when a market order hits a limit order, they execute at the limit price. When 2 limit orders cross, they execute at the “earlier” limit price.
Therefore, on the exchange, I believe all trades execute either on the best bid price or best ask. I guess all the mid-quote executions happen on the ATS’s.
Dark pool is required to report trades to the regulator, but often with a few sec longer delay than an exchange.
Dark pool may define special order types beside the standard types like limit orders or market orders.
Forex is quote driven, not order driven. Forex has no exchange. The dominant market is the interbank market. Only limit orders  are used. However, within a private market operated by a single dealer, a “market order” type can be defined. I feel the rules are defined by the operator, rather than some exchange regulator.
 A Forex limit order is kind of fake – unlike the exchange’s guarantee, when you hit a fake limit order that dealer may withdraw it! I believe this is frowned upon by the market operator (often a club of FX banks), so dealers are pressured to avoid this practice. But I guess a dealer may need this “protection” in a fast market.
I guess internalization is not automatic. Special logic needed.
Brokers can also match up buyers and sellers on their own in a process known as “internalization.” If one client wants to buy 100 shares of Advanced Micro Devices and another wants to sell 100 shares, the two orders could be matched up internally, and Robinhood could collect the very small difference between what the buyer pays and the seller receives.
———- a veteran’s answer ———-
“I don’t think we have logic locally to cross against firm automatically. The trader would have to send an explicit order to cross against firm. There is a Smart Order Router layer that intercepts order and they may have some logic there to automatically cross against firm.”
On 6/20/2012 3:10 AM, Bin TAN (Victor) wrote:
See job spec below about “internalization”. Is there non-trivial business logic about that in your system? I guess if a client places a limit buy order and the internal best offer is better than the exchange best offer then do it internally. Is it that simple or there are hidden complications.
Not sure about market orders but I guess if the internal best offer is better than the exchange best offer then obvious…
Q: What’s a busted trade. How can it be busted?
Q: If I send a IOC sell of 12.05 but the best bid is $12, how could this be filled?
I believe IOC / FOK are all limit orders. Market orders are implicitly IOC — if orderbook is (almost) empty on this side, the market order is (partially) cancelled.
Q: what’s a resting order?
Q: if a sell limit order is $27 and a new buy limit order comes in at $28, what would be trade price?
A: $27. new comer is given the best price available. Note the buyer doesn’t know what the best offer would become when his order hits the book, so he uses limit order not a market order.
Q: what’s away order?
Q: whats intermarket sweep order