• November 28, 2023

NMS II Doesn’t Fix the Odd Lot Problem

B.Before the pandemic, many traders looked at the rise in stock prices and their wider spreads and found that this was the cause increase odd lots. The SIP committee even proposed Adding an odd BBO to their feed, though most of the criticism It was about whether one or the other BBO would actually play a role as it was not protected or had to be shown to investors.

Just a few months later, the SEC suggested changing the round lot sizes instead. Today we’re looking at how strange the SEC’s solution looks.

What the SEC (now) proposes

Under the SEC’s original proposal, orders as low as $ 1,000 would have set the value NBBO. Most commentators said that was too low, especially when the average trade is closer to $ 10,000 and Retail orders cost around $ 8,000 on average. Although spreads may have been tight, many market orders may have been “traded” on the new flat best quotes, making it difficult to explain the fill prices and Rule 605 Execution quality metrics for customers.

So the SEC adjusted theirs original round lot proposal Include only stocks over $ 250. This effectively increased the minimum order quantity required to set the NBBO at $ 10,000 to $ 100,000 based on the price of each share (excluding BRK.A).

The new round lot sizes work as shown in Table 1 below:

  • Share price from $ 250.01 to $ 1,000.00: round lot = 40 shares;
  • Share price from $ 1,000.01 to $ 10,000.00: round lot = 10 shares; and
  • Share price over $ 10,000.01: round ticket = 1 share.

It is important that the new rules now also protect the smaller NBBO quotation marks. The original proposal allowed small quotes to be traded, which may defeat the purpose of adding smaller quotes to the SIP.

Graphic 1: How the new dynamic round lots change the value required to set the NBBO

How much impact will this really have?

Interestingly, this will only affect 158 ​​stocks.

However, these stocks make up around 24% of the total traded value (although only 1.8% of all stocks traded due to their high share prices). The data also shows that over 80% of the stocks affected are large-cap stocks (Figure 2).

Chart 2: Number of stocks affected by the new rules for odd lots (color according to market capitalization)

Number of stocks according to price groups

This will not remove any odd lots in the NBBO

As can be seen in Figure 1, there is still room for odd lots to set prices within the NBBO.

Based on our analysis of existing odd lot offers for Nasdaq listings is exactly what the data suggests and even allows odd lots to be aggregated until they form a (new, smaller) round lot for the SIP.

In fact, most Nasdaq 100 stocks above $ 100 still have a better odd lot offer than the SIP offer more than 50% of the time. That’s a drop of over 70%, but it’s still high enough to be asking best-ex questions.

However, we do find that odd lot orders that are priced to improve the NBBO drop significantly in value, especially for very high-priced stocks. For example, the average value of odd lot price improvement in AMZN is nearly $ 125,000 today. In the new market, this is less than $ 10,000 (circle sizes in Figure 3).

Figure 3: Estimated new percentage of odd lots within the NBBO

The percentage of time Nasdaq was at the top of the book was less than new NBBO

But it should tighten spreads

Buyers and sellers of stocks form fairly consistent supply and demand curves (Figure 4). When a price moves away from the center, the spread increases, as does the amount available to buy and sell. Plot this forms a V shape that studies find has the same slope regardless of how far apart the bids and offers are. We show how this works in Figure 4: 10,000 stocks are available five cents away from the center, regardless of whether they are listed on one price level (bid side) or on five different price levels (supply side).

Figure 4: Volume accumulates at the same rate regardless of which tick increment is used. For the same reason, reducing the round lot allows a smaller supply (or demand) to form the NBBO

Hypothetical $ 100 stock in the 5 cent versus 1 cent market

This also has an impact on the spreads on high-priced stocks. In essence, the spread required to provide $ 100,000 in liquidity is higher than the spread required to provide (or request) $ 10,000 in liquidity. Therefore, reducing the round lot sizes should reduce the spreads proportionally.

As Figure 5 shows, high-priced stocks now require a much larger supply and demand to qualify for the NBBO (light green bars).

We also know that, especially for high-priced stocks, not everyone would like to trade in the size required to manufacture NBBO. In essence, these stocks are “round lot restrictedThis results in wider spreads than others similar stocks (U-shape to the orange line).

Given what we know from Figure 4, the expected spreads for stocks worth $ 1,000 should decrease by 90% as the round lot of 100 stocks falls to 10 stocks (by 90%) (dotted orange line in figure 5).

However, our data on Nasdaq 100 stocks suggests that the odd lots we are currently seeing in combination with the proposed rules for smaller round lots may tighten spreads much less (dashed orange line).

Chart 5: Current data suggests that spreads are not tightening as much as expected

Spreads over stock prices

A strange result

Weird lots on the market is one of the few issues that almost everyone seems to (mostly) agree on. Unfortunately, it has proven difficult to come up with a solution that everyone can agree on. Retail investors with small orders deserve the most competitive lighted prices the market can offer, while institutions need liquidity and spreads worth trading on the exchange.

As we found last weekInvestors are already sending orders that are smaller than (even) the proposed new round lots. Today’s data suggests that odd lots will still be a bigger problem than traders would like.

A better solution is a market where all orders count equally and the illuminated supply is as competitive and comprehensive as possible. At the same time, it ensures that the spreads are deep enough to fill most orders.

Unfortunately, resetting round lots only changes the problems we already have.

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