Chapter 24
Specialists
NYSE Structure
1366 members (specialists & floor brokers)
 Seat = Member = Right to buy & sell on
the NYSE Floor
Approximately 3000 listed companies
Specialists
7 specialist firms
Approximately 450 specialists
Typically 5 to 10 years on-the-job training
Handle equities across all industries
Most individual specialists handle
between 3 and 10 stocks
Stocks
Each stock assigned to one firm
Stocks allocated one of two ways:
•
Allocation interviews
 3-5
Specialist firms participate in 30 minute
interviews

•
Either by phone or in person
Assigned by NYSE Allocation Committee
Each stock trades at one location on floor
Specialists’ affirmative obligations
Specialists are traders of last resort.
• Have to quote firm two-sided markets
during trading hours.
 Specialists have an obligation to smooth
prices by intervening to prevent large price
reversals (provide price continuity).
• Expensive if informed traders in the
market.
• Profitable if the spread is wide because
other traders are distracted.

Exchanges regularly evaluate specialists
based on the width of their quotes, the
depth at their quotes, and price continuity.
 Specialists provides
• Liquidity when there are order imbalances
• Price continuity
• Limit order display
• Supposedly stabilize prices

Specialists also do…



Specialists also work orders entrusted to them
by floor brokers. Specialists generally charge
brokers commissions for these services.
Specialists act as oral bulletin boards for brokers.
Specialists have a responsibility to make sure
that all traders follow the exchange rules.
• Conduct an orderly market.
Specialists’ negative obligations
Abide by order precedence rules, including
public order precedence rule.
 Public liquidity preservation principle is
typically enforced at primary exchanges.
• Specialists can trade only with incoming
marketable orders.
 Third market dealers and regional specialists
are generally not subject to the public
liquidity preservation principle.

Specialist privileges

Specialists can engage in:
• Speculative trading on their own account
based on their ability to predict short-term
price changes
• Quote-matching (see p. 249)
• Cream-skimming - observe broker IDs for
incoming market orders and step in front
of the book by improving the price
• Strategies to take advantage of stop
orders
Specialists control the quotes
• Limit display to top-of-file – most valuable
• Constrained by order exposure rules
 Specialists can stop incoming marketable
orders.
 Specialists conduct the open.
 Specialists receive brokerage commissions
for system orders.
 Specialists have a unique information
advantage that they can use to generate
dealer profits.

Specialist Profitability: A
Challenging Environment
Seat Prices Down 40% from highs
 Current return on Specialist Capital near
zero

5/1/2003
4/1/2003
3/1/2003
2/1/2003
1/1/2003
12/1/2002
11/1/2002
10/1/2002
9/1/2002
8/1/2002
7/1/2002
6/1/2002
5/1/2002
4/1/2002
3/1/2002
2/1/2002
1/1/2002
12/1/2001
11/1/2001
10/1/2001
9/1/2001
8/1/2001
7/1/2001
6/1/2001
5/1/2001
4/1/2001
3/1/2001
2/1/2001
1/1/2001
12/1/2000
NYSE Seat Sales
December 2000 - Present
$2,800,000
$2,600,000
$2,400,000
$2,200,000
$2,000,000
$1,800,000
$1,600,000
$1,400,000
$1,200,000
$1,000,000
Top Line Revenue Pressure
QTRLY Specialist Revenues as a Percent of Volume
Annualized
2.5
Pennies and
Dow 12000
2
1.5
1
Dow Loses 10%
0.5
Source:
NYSE Website and Bloomberg
3
3Q
-0
3
1Q
-0
2
3Q
-0
2
1Q
-0
1
3Q
-0
1
1Q
-0
0
3Q
-0
0
1Q
-0
9
3Q
-9
8
9
1Q
-9
3Q
-9
8
1Q
-9
7
3Q
-9
1Q
-9
7
0
Specialist Return On Capital
(excludes NYSE Specialist Investigation Settlement Charges)
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
Source: NYSE Website
0.0%
7
7
8
8
9
9
0
0
1
1
2
2
3
3
-9 -9 -9 -9 -9 -9 -0 -0 -0 -0 -0 -0 -0 -0
1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q
Recent Controversy
 Issues surrounding former NYSE CEO Dick
Grasso and SEC’s specialist investigation occur
simultaneously
 Results:
•
•
•
•
Reputation decline for NYSE
Decline in market share
Dual listing on NASDAQ of 7 stocks
Dramatic decrease in NASDAQ transfers
 Despite these issues, NYSE still capturing bulk
of IPO volume
Chapter 25
Internalization, Preferencing,
and Crossing
Discuss JFE paper