Thursday, 22 June 2017

IEX MM-Peg follow up

It has been pointed out to me by more than one person that though they are not fans of IEX they would like to see the MM-PEG order allowed as submitted. I poured scorn on this order type here, "IEX's new order's unintended consequences."

My scorn stands but I understand the dilemma best captured by Mr Adam Nunes here,

The issue that this order type is addressing is having a continuous presence in the market. This is the rather ridiculous requirement set to a one hundred percent obligation for official market makers in the US.

Now, this order type is not really ever expected to trade. It is close to a spoof in that regard except for the idea that you'd be happy if it did trade. Such a happy intention takes it away from being a spoof, but the silliness remains. That is, buying 8% below the NBBO or selling 8% above the NBBO would likely be welcome.

The issues around the timing of the order are real in that it may bake in a systemic advantage or disadvantage at that price level, far from the market where it doesn't really matter. This may then set a precedent allowing IEX to extend such a latency problem all the way to the BBO which would be a bigger problem.

The right answer would be for the SEC to only require market making obligations for some high but not crazy percentage of the time, say 95%. Then this order type, that is never expected to trade, would not be required. We need to fix the issues rather than skirt around the edges with such MM-Peg artifices.

I do wish we could stick to a small set of atomic primitives from which all order types may be created. Then participants could ignore the more complex order types if they chose to. Until then, we'll all have to be "puzzle masters."

Happy trading,


Tuesday, 20 June 2017

IEX's new order's unintended consequences

IEX offered up for the SEC's consideration a new order type last week, "Proposed rule change to introduce a new market maker peg order."

The new Market Maker Peg Order, or MM-Peg, is not an unreasonable order type. I've long been on the record as opposing unnecessary order types and this fits that category. It is similar to order types on other exchanges. The innovation is limited. However, MM-Peg adds to the order proliferation pollution problem that IEX has long promised it would avoid. Here is an excerpt from Flash Boys concerning the puzzle masters,

(click to enlarge)

Back in 2014, IEX was promoting the idea of simple order types,
"Only four types of orders – IEX eschews certain types of orders that were created to accommodate the HFT crowd, such as the Post-Only order and “Hide Not Slide” order. Instead it offers only four basic types of orders – market, limit, Mid-Point Peg, and IEX Check (Fill or Kill). The Mid-Point Peg gives the investor a price between the current bid and offer for the stock."
Well, we've moved on from there with the Discretionary Peg and its complex conditions and changing formulae with its high false positive rates. The crumbling quote factor as been added to the Primary Peg. And now we behold the MM-Peg, a displayed peg that has priority over non-displayed. Not a big deal in itself as it is just a small incremental extension. A bit of an outhouse, really. IEX is simply replicating the same utility payoff for order type development that has got us into this NMS order type mess in first place. All may make sense in isolation but who wants to fly in such an NMS Rube Goldberg contraption?

IEX is no different from other exchanges with such order type development. The market order proliferation problem needs some kind of "start" agreement where these arms are controlled. The only real beneficiaries of the current proliferation are the sophisticated market participants that have the resources and skills to puzzle out all the order puzzles and apply them to their problems as solutions. HFTs might just fit into that category. IEX's biggest traders are HFTs. This may be the outcome they are looking for.

So, this little bit of hypocrisy on IEX's part cuts a little deep to their core values. This order proliferation has long been something the "puzzle masters" have protested loudly against. Not a big deal as a piece of incrementalism but, nevertheless, surprising as order type proliferation is a real problem to which IEX is succumbing. Why is it surprising? Well IEX has rallied against a number of things such as rebates and co-location, both of which may actually benefit markets and yet on order types - they continue to transgress on their values. Curious.

The big issue

The main issue I see with the MM-peg is that it may bake in a strategic advantage in latency to particular types of customers, "The Market Maker Peg Order would be limited to registered market makers" [page 6].

I read it that the repricing still has to go through some guise of 350-microsecond delay, perhaps even the original magic shoe box,
"Furthermore, pursuant to Rule 11.190(b)(13), each time a Market Maker Peg Order is automatically adjusted by the System, all inbound and outbound communications related to the modified order instruction will traverse an additional POP between the Market Maker Peg Order repricing logic, and the Order Book."
However, this isn't the problem directly. The problem is how the latency may compare to co-located access from NY5 where the POP is. That is, how does it compete against the exchange's own customers?

The exchange's network architecture should have reasonably good/low jitter due to it being 10G Ethernet. It is hard to do that really badly, so let's assume IEX haven't stuffed that up. The latency difference between customers in NY5 on the customer facing side of the POP and the internal MM-Peg repricing mechanism may then be implied to be significant for all or some set of customers. That is, significant in terms of expected jitter. That difference may be advantageous or disadvantageous due to those reified architectural differences. That is, the timing is largely baked in.

If MM-Peg was to have a benefit in terms of latency, that would be bad as you are forced to use it and eschew other order types, but only if you can. You may not be a registered market maker and be at a structural disadvantage. The other side of the coin is a baked on disadvantage implying you never want to use an MM-Peg. Then again on some day, it may magically improve due to some technical rejigging. What if it changes without you knowing and suddenly your trading is at a surprising disadvantage? I'm imagining Haim Bodek breathing fire. I agree with him. This is a poor situation.

Either faster or slower is problematic for IEX's customers. It is a no-win situation - caveat emptor.

And, just to add fuel to the fire, SIP customers may be notified of the requotes before the IEX customer waiting at the IEX pop.

Happy trading,



Note: much to do about nothing. This is all about an order type that lives "at least" 8% (IEX rule 11.151(a)(6)) away from the BBO if it is an S&P500 or Russell1000 name. Busy work that is an unprincipled precedent. You have to wonder why they'd bother with it.

PS: Kipp Rogers points out that it was only three order types back in the Flash Boy daze of 2014: 

Wednesday, 14 June 2017

Rebate trafficking

The mass debates around rebates are coming to the point where the tumult paints rebates more akin to drug trafficking than a sensible approach to attracting custom.

This cult-like lack of economic argument is centred around the Franken-pool of IEX. Mr Katsuyama was quoted by Nicole Bullock in her June 1 FT article, "IEX chief sticks to principles in battle for presence",
“At the end of the day, this conflict between brokers getting paid a rebate by the exchange or getting the higher quality execution for their client — that conflict is going to come to a head and we’ll be the beneficiary of that,” says Mr Katsuyama, who insists that IEX gets better executions for clients.
It's not a rational argument and a typical misdirection from IEX. The argument is often accompanied by incendiary language referring to rebates as kickbacks. For example, here is Mr Elvis Picardo writing in Investopedia, as replicated by Forbes, from April 2014, "How IEX Is Combating Predatory Types Of High-Frequency Traders",
"No kickbacks or rebates – IEX does not offer any special kickbacks or rebates for taking or making liquidity. Instead it charges a flat 9/100th of a cent per share (also known as 9 mils) for buying or selling a stock."
IEX has referred to rebates as kickbacks, "'s a kickback.." [4:05]. Kickbacks are normally associated with illegal behaviour. It is not a term that should be used lightly, just as front-running is also criminal and poorly used by IEX. Such aspersions are why the debate gets heated on both sides leading to a lack of rational rationale. IEX fail to recognise that zero pricing for lit at IEX would meet their own description of a kickback as a kickback is a remunerative, not monetary, exchange. Giving something away for free, such as an order execution, might also be considered a kickback; as may something for a discount. So if rebates are kickbacks, then IEX is also offering kickbacks. It becomes a matter of degree. Loss leaders at a store would also be a kickback. It's a silly, shameful argument. Perhaps an exchange offering rebates will sue Mr Katsuyama?

I've written on the subject previously in 2015, "Trading rebates - a choice, not an evil." It is a tired debate. It's really not worth dredging up again, yet here we are. Rebates are often paid for posting prices, sometimes for taking as per inverted exchanges, some charge zero, and some charge flat fees. IEX's dark orders have the highest fees in the industry with 0.0018 per round trip.

There has been much experimentation and it continues. BATS not only offers both maker-taker and taker-maker inverted pricing but has introduced low flat fee pricing at one of its exchange platforms (EDGA) with 0.0003 a side or 0.0006 cost per round trip. May the innovation continue.

Higher rebates!

Fees, and rebates by implication, were capped by Reg NMS in 2005 at 0.003 per share. I'm not a true blue believer but I can make an uneasy fair dinkum argument for higher fees and rebates that I think is not completely stupid.

Part of the modern problem with PFOF and dark liquidity is that they skin the restrictive sub-penny rule in a way that cannot be approached with penny oriented quotes. I've written about this previously in "Sub-pennies rule!" The supply and demand at a public market are a careful balance of what can be earned in the nett spread which is the sum of the spread, transaction costs, rebates, and other amortised expenses. Changes to transaction costs and rebates affect the desirability of market makers, in particular, to trade at the exchange. If the costs were 0.005 on both sides with an average gross spread of just a cent, 0.01, you wouldn't bother trading there as you couldn't earn any money. That's not completely true as maybe you could pay the 0.005 and do the other side at another exchange earning the cent spread, giving you a positive nett, but you get the idea.

Now if you think about it, a rebate of 0.005 with a cost of 0.005 for the other side, or other 0.005 permutations, could give you the equivalent of a mid-point pricing for trading if you consider a 0.01 spread typical. That could be an argument that holds water for as to why the 0.003 ceiling is currently too low. That is, an argument for a more permissive cap to accommodate innovation is not completely lacking. I don't buy it, yet. I prefer the direction promoted by some at EMSAC that advocate for lowering the 0.003 cap, but I'm not totally convinced.

There may be other ways that exchanges could use fees to combat the advantage that PFOF and dark orders have in skirting the sub-penny rule. For example, imagine that when you submit your order instead of just price, time priority, you pay for a priority level at the price. That price could be negative - a rebate. It would partially change the time priority to that where the priority has a market mechanism, a price. You could make a strong argument for such a beast. I'm not sure how the market would react, but I suspect the exchanges would likely make a lot more money in fees which could be partially rebated back to the customers to maintain a competitive advantage. It is not sub-penny pricing but it is a close cousin. Such a scheme may allow public exchanges to compete more vigorously against the incursion of PFOF and dark orders with their micro-cent fills. I'm not sure I like the thought of this innovation but it has some merit, as do higher rebates.

Overall, I'm agnostic on rebates. I could take them or leave them. Rebates have a useful role in innovation and perhaps there is more innovation yet to come. I do think the current discretion within the 0.003 fee cap is a pretty good balanced result for now. There is certainly merit to both a higher and a lower cap, but crass arguments about kickbacks have no role in the debate.

Happy trading,


Update: Mr Osman Awan correctly pointed out on Twitter that it is only fees, not rebates, capped by Reg NMS. There is no reason why a rebate could not be 0.005 today except for the long-term necessity for profit. That is, a rebate cap is implied, not required.

Thursday, 1 June 2017

IEX statistics for May: the devil is in the details

A reader may know by now that I'm not a huge fan of the IEX hubris and hypocrisy emanating from their general direction concerning their speed-bump. The smart HFT will continue to worry that such market structure debauchery will harm the market in the longer term even if it provides opportunity in the short term. HFTs rely on healthy markets. IEX's Dark Fader does not promote market health.

As you can see in the following table, IEX's dark and expensive share restaurant continues to darken. Not one day in May had over twenty percent of displayed volume trading as a proportion of total shares handled.

Lit / total handled
May 17.5%
April 18.7%
March 19.8%

IEX had an improved, albeit small, market share in May of around 2.2%. The devil is in the detail and in the following chart, the May detail devils are highlighted for your amusement or apprehension.
May details are devilish
(click to enlarge)
You'll see that in the unlikely event that a linear relationship was to hold, you would expect IEX to be completely dark if it was to grow to 8% of the market. This may be a consequence the SEC did not intend.

A more traditional view of lit volume traded versus total shares handled is the following chart:

(click to enlarge)

To me the surprise is not why IEX lit activity is below twenty percent, it is why investor naivety is such that IEX trades at all.

Sunshine continues to be a great disinfectant. Let's all hope for the sunrise as the IEX dark moon rises.

Happy trading,



Older IEX related meanderings: