MIS 3090
IT for Financial Services
The Search for Liquidity:
Solving the OptiMark Problem
Characteristics of an Ideal Market
 Certified
confidentiality
 Price discovery at all sizes
 Liquidity available
 Most
important factor according to research
 A frequent
call or continuous market
 Cancellations at electronic speeds
 Low cost… “transaction implementation cost”
phenomenon or block trade problem
March 14, 2016
2/17
The Block Trade Problem
Funds managers and other must trade large
amounts of stocks
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A block is >=10000 shares
Inst. trading accounts for 75-80% of NYSE volume
Mere news of a block trade can distort markets
before trade is executed
Traders take advantage of news
Leads to higher transaction costs (3% of a round
trip transaction goes to transaction)
March 14, 2016
3/17
The Block Trade Problem
Break down of block trade costs
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Commission
Bid/ask spread
Timing cost
Opportunity cost
Total
0.13%
0.27%
0.43%
0.53%
1.36%
March 14, 2016
4/17
Current Strategies for Dealing with
the Block Problem
Convey full order to market
Contact a dealer on the block trading
desk
Shop the order
Slice the order
Use Instinet or other continuous order
matching system
Use ECN or ATS to match bid/sell
March 14, 2016
5/17
Transaction Costs (another study)
According to the Plexus Group, institutions on average incur
hidden transaction costs of $.39 per share for every trade they
make. This amounts to $100 billion in transaction costs each year.
change in
stock price
Announcement Costs
March 14, 2016
6/17
Evolution of OptiMark
“Optimal Markets” launched in 1999 with
collaboration of NASDAQ
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Over 2000 brokers trained backed by major
brokerage firms
PacEx, Osaka, and Toronto exchanges signed on
Quantitative method for coming up with the
“optimal” matches for buying and selling
Innovative use of GUI for determining preference
profiles
March 14, 2016
7/17
When and how would a dealer use Optimark rather
than another market source?
Options
When
How
Nasdaq
Desire to place order with a
single price and quantity
Loose network of broker-dealers serving as
market makers. Use own K to buy/sell stocks
and profit from spread between bid/offer
prices quoted “real time”
NYSE
Desire for order driven trades
of listed stock in auction
market model
Labor intensive
Physical floor
Via a specialist (1 market maker)
ECN
Desire to display order
anonymously but disclosed to
traders
Seek lower cost structure
Screen order book displays bids/offers of
investors and continuously matches orders
electronically (ex. of continuous order
matching system)
Optimark
Desire to place multiple orders
with multiple price and
quantities without disclosure
to traders
Indicate “willingness” to buy via graphical
interface designating preferences
Algorithm continuously matches orders
electronically
March 14, 2016
8/17
OptiMark: Buy-side and Sell-side
 Large
institutional investors such as mutual
fund or pension managers on the “buy-side”
 Brokerage firms on the “sell-side” to help out
their institutional clients
 Small retail investors who benefit from
matching the aggregated interest of other small
traders to a large investor
March 14, 2016
9/17
Optimark benefits…
Anonymous
Laddering of orders
GUI for developing a trading “profile”
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3-D rendering of price, quantity, satisfaction weights
Encourages full disclosure of true trading intentions
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Lead to trades that would not occur otherwise
Add to liquidity
Tries to improve upon “reservation” prices
First executes matches where buyer and seller express “full”
(i.e. 1.0) satisfaction, then ladders the trades
March 14, 2016
10/17
Innovative Idea
New means of representing trading strategies based on
simple color visualization of preferences
Lighter colors reflect greater satisfaction
For larger
orders, I would
be willing to
pay more just
to get the order
executed
Buy order
Signal willingness to pay a little extra to have the order completed
March 14, 2016
11/17
Graphical rendering
March 14, 2016
12/17
Fees: OptiMark vs. Others
– Revenues from commissions which can
be 5 –10 cents a share, bid-ask spread and market
impact, timing cost and opportunity costs
 ECN – Charge their users-per share access fees and
charge commission to dealers
 OptiMark – Transaction fee of one cent per share
from each side of a trade for member's own customer
accounts. For trades in customer accounts, fee is paid
out of brokerage commission
 NASDAQ
March 14, 2016
13/17
Value Proposition for Institutions
Traditional Costs
OptiMark’s Cost
Trading cost for an Institution
Commission
0.13 %
Bid-Ask-Spread 0.27 %
Timing Cost
0.43 %
Opportunity
0.53 %
Total
1.36 %
Sell 1¢ / Share
Buy 1¢ / Share
Total 2¢ / Share
100,000 shares of Microsoft bought & sold at $50
Sell .0136% x 100,000 x $50 = $68,000
Sell 100,000 x 1 ¢ = $1000
Buy .0136% x 100,000 x $50 =$68,000
TOTAL = $136,000
Buy 100,000 x 1 ¢= $1000
TOTAL = $2,000
March 14, 2016
14/17
NASDAQ – OptiMark Connectivity
source: http://www.nasdaqnews.com/news/optichart.html
March 14, 2016
15/17
OptiMark Troubles
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$236m in funding from Merrill Lynch, Goldman Sachs,
CSFB, PaineWebber and Softbank ($100m alone)
Revenues $3m in 1999 – 75% came from 4 users!!!
Typical daily volume was 1m shares, a few 3m+ days, so
revenues were low (1,000,000 x $0.01 = $10,000); this
eventually declined to 100k shares per day
Not a specialist, so they could not provide capital or a source
of liquidity to ensure a fair and balanced market
Officially, they could trade 250 NASDAQ stocks, but their
system was so complex, they could only manage 10
Most of their matches were found on the NYSE: ITS penalty
 Provided basis for development of SuperMontage
March 14, 2016
16/17
STP for Institutions
Straight-through processing
DTCC initiative for cutting down
settlement to T+1
Decreases settlement risk
March 14, 2016
17/17
Dividend Reinvestment Plans (Drips)
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Corporations can sell stock direct to consumers
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What’s the share price?
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Uncertainty – you don’t buy at the market price
Advantage
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You have to be an existing shareholder
If you own shares through Schwab or a similar broker, the shares
are held in a nominee account and not in your name so you would
need to have them issue you with a certificate in order to get the
stock into your name and to enable you to participate in DRIP
Really cheap
Buy and Hold
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Uncertainty when you sell as to what the market price will be
You will pay regular sell commissions for the company to buy
back your shares
March 14, 2016
18/17
Dividend Reinvestment Plans (Drips)
Sharebuilder.com (bought by ING
DirectInvesting.com
March 14, 2016
19/17
Stock Screening – analyst ratings
March 14, 2016
20/17
Stock Screening – by sector
March 14, 2016
21/17
Questions to consider…
What is a block trade and what are the
problems with these?
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What is the most desirable factor?
What
What
What
What
What
options do traders have?
is the cost structure?
was Optimark and how did it work?
is STP?
is a Drip?
March 14, 2016
22/17
For Next Class…
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Read
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Read the Shenzhen Stock Exchange case study (emerging markets)
We will review the case in class and discuss some other international
initiatives to design efficient equity markets
March 14, 2016
23/17