Series 7 Trading Markets Section

Primary Market
New issues being sold for the first time
Secondary Market
Trading of issued securities
Divided into 4 sub-markets
First Market
-Trading of exchange listed options
-NYSE, AMEX, NASDAQ and regional stock exchanges
-About 3,000 companies traded on NYSE with average volume of over 1 billion shares
Regional Exchanges
Dual Listings
Stocks that trade on more than one market venue
-Used to be that market places required exclusively from corporations that traded on each of the exchanges
-SEC viewed this as anti-competitive
Consolidated Quotations System (CQS)
Provides centralized place for price quotes in exchange-listed securities regardless of the source of the quote
Network A Tape
Reports NYSE listed issues regardless of the market center where the trade takes place
Network B Tape
Reports NYSE-MKT (AMEX) listed issues regardless of the market center where the trade takes place
NASDAQ Stock Market
A fully linked electronic market which has listing standards competing with the NYSE
-Trade under a Unlisted Trading privilege basis
-Uses UTP Quote Data Feed
UTP Quote Data Feed (UQDF)
Provides current price quotes regardless of the source of the NASDAQ quote
Network C Tape
Reports trades of NASDAQ issues, regardless of the market center where the trade takes place
Trade on exchange floors with the largest being the CBOE
International Securities Exchange
-Trade Options
BONDS usually trade.....
OTC, but the NYSE does limited trading go corporate bonds of some NYSE listed companies
Second Market
Over the counter trading of unlisted securities
OTC Bulletin Board
-display facility run by FINRA for publicly traded companies that cannot meet exchange standards
-Not an exchange nor a self regulatory organization
Pink OTC Markets
Used to publish pink sheets bus has been transitioned to an electronic inter dealer quotation system for broker-dealers to trade unlisted securities
What else trades OTC?
-Corporate Bonds
-Commercial Paper
-US Gov'ts
Sold OTC
New issues
Third Market
OTC trading of exchange listed securities
-Vie with exchanges by trading slightly better prices than the exchange to grab an order that would otherwise be routed to that exchange
-Stays open 24 hours to trade with others when the general markets are closed
Payment For Order Flow
Market makers are allowed to pay a small amount to retail member firms that direct the order to that market maker
-as long as payment for order flow is disclosed on customer trade confirmation
Fourth Market
-Direct trading of securities between institutions OTC-companies bypass brokers and large commissions
Electronic Communications Networks
-Computer networks that match customer orders to buy and sell 24 hours a day on an agency basis
The first institutional intermediary to broker institutional trades at smaller spreads than market makers
-Now owned by NASDAQ
Regulation ATS
Alternate Trading System
-used to address the growth of ECNs
-requires ECNs, Dark Pools and firms' internal trading systems to be registered with the SEC and regulated as broker-dealers
-Must link with a national securities exchange so that the ECN quote is displayed and can be accessed
Dark Pools
Operated by the larger broker-dealers that allow institutions to buy/sell very large blocks without displaying their orders in the ADF or in a display system.
-Called this because of the size of the trade and the identity of the institution not being displayed.
Alternate Display Facility (ADF)
Created to display ECN quotes if the ECN wasn't going to post its quote in an exchange order book
After Hours Market
Customers who wish to trade outside of regular trading hours should know that there is less liquidity and a greater price volatility
Regulation NMS
Consists of Rules 600-612 which impact market participants
3 Major NMS Rules
1. All market centers must enforce policies to prevent "trade throughs" which is executing an order at an inferior price to that displayed by any other market
2. When providing access to their markets, market centers cannot favor one firm over another
3. Sub-penny pricing is prohibited for NMS stocks trading at $1 or above
Rule 602
Exchanges must collect display bids and offers
-Requires each exchange to collect bids offers and quotation sizes from broker dealers
Rule 604
Limit Order Display Rule
-Requires exchanges and market makers to display customer limit orders publicly so that they can be accessed by everyone
Rule 605
Market Center Order Execution Report
-Requires market centers to prepare and make available monthly reports summarizing order execution including data on:
-bid-ask spreads
-how market orders of various size were executed
-speed of execution
-fill rates
-price improvements or dis-improvements

OTCBB and Pink sheet executions are excluded from the report
Rule 606
Reports to Customers on Order Routing and Payment Order Flow
-Firm pays a small amount to that retail member that directs the order to the market maker
-requires disclosure of payment for order flow on customer confirmation
Rule 607
Customer Notice of Payment for Order Flow
-Each broker dealer must notify each new customer at account opening and annually thereafter of policies regarding receipt of payment for order flow and the compensations received
Rule 611
Trade-Through Rule
- all markets that quote NYSE, AMEX, and NASDAQ stocks must be electronically linked and any executable order must be executed at the best price, within 1 second
Rule 610
Market Access
-There are multiple trading platforms for equities, all orders must be executed without discrimination.
Rules must prevent locked and/ or crossed markets
Rul 612
Sub-Penny Quoting
-Minimum increment is $.01 if trading higher than $1
-If lower, minimum is $.0001
-Makes markets in and maintains inventories of securities
-Quotes in bid and ask with the difference being the spread
Specialist/Designated Market Makers (DMMs)
-Dealers on the NYSE trading floor with there only being one per NYSE stock
-Cannot deal with the public, only deal with retail members of NYSE
Market Makers
-OTC dealers who register with FINRA and are expected to maintain a market in an issue
-NASQAD uses a system of competing market makers thus there are multiple for each stock
-OTC firms are allowed to act as broker or dealer but not both at the same time
Non-NASDAQ Market
-Not electronically linked like OTCBB and Pink OTC markets are
-Display facilities only
-Must negotiate with market maker
How does a broker make money?
How does a dealer make money?
Mark ups
Order Ticket Information
To place an order, the rep fills out an order tix either on paper or electronically
Regulation SHO
Requires that the broker make sure that the borrowed shares can be delivered on settlement, among other things
Day Order
Cancelled at the end of the day if not filled
Good till cancelled
Good through week
Good through month
Who's responsibility is it to cancel orders that can't be filled in allotted time?
The firm's
All or none; several attempts can be made to try and fill the order otherwise the order is filled or order is not executed
Fill or Kill; one attempt can be made otherwise cancelled
immediate or cancel; try to fill as much as possible on one attempt, unfilled portion is cancelled
2 possible trades, one side is filled and the other is cancelled
-if partially filled, remaining amount applies to both remaining orders
Not Held
Trader will hold back if he thinks order can be better executed at another time
Customer hasn't specified security and size of order
Do not reduce; on ex date orders are reduced to reflect loss of dividend, if DNR is specified order is not reduced
At the opening/ at the close
to be filled at opening or at the closing price otherwise cancelled
Market Order
No specific price is specified, just filled at prevailing market price
Limit Order
-A limit to buy is to be filled at that price or better
-A limit to sell is to be filled at that price or better
-A stop order to sell is filled if the market price falls to that price or lower
-A stop order to buy is filled if the market rises to that price or higher
SLoBs and BLiSS
Stop-Limit Order
-Once triggered the order now becomes a limit order
-Buy Stop-Limit elected at the stop price or higher and executed at the limit price or lower
-Sell Stop-Limit elected at the stop price or lower and executed at the limit price or higher
Resistance Level
Breakthrough is bullish
Support level
Breakthrough is bearish
How the exchange functions
NYSE has floor-based trading and a computer order matching system
The electronic trading book for NYSE Classic
-routes orders electronically to either a floor broker or the NYSE (DMM)
Floor Broker
Employees of each brokerage firm, acting as agent only to fill customer orders
$2 Broker
Assists brokerage firm, but is independent of it
Exchange Member
-Acts as a market maker in assigned securities- 1 DMM per stock
-Executes market orders to buy that active via SuperDisplayBook and match these orders with sell orders that are present and also executes limit and stop orders placed in the DMMs book
Market-Not Held Order
An order routed to a floor broker, where it is not held to immediate execution. Here, the floor broker tries to get a better price than the current market; customer orders have priority
Gets virtually instant order matching and execution
Super Display Book
-Automation of the trading process that routes orders directly to DMM's trading post for execution.
-Executed trade is reported back directly to the entering firm
What type of order does the NYSE not accept?
Stop limit orders; member firms have to accept and place in internal systems
How are orders filled?
How often are old orders that are GTC renewed?
At least twice a year
What happens on the ex-date with cash dividends?
-Orders placed below the market are reduced (BLiSS)
-DNR orders and orders above the market (SLoBS) are not reduced
Stock Dividends/ Stock Splits
-DMM adjusts open orders
-Stock splits or stock dividends that result in round lots-number of shares increased and price is reduced
-Stock splits or stock dividends that result in odd lots-number of shares adjusted to the nearest round lot and price is reduced
-Reverse stock splits- all orders cancelled
DMM's Positive Obligation
The DMM must buy stock if there are no other customers buying or sell stock if there are no other customers selling
DMM's Negative Obligation
If there are already buyers and sellers ready to trade, the DMM cannot interposition self between willing traders
DMM can perform "Stopping Stock"
DMM can "stop" stocks for public orders and cannot stop stock indefinitely, only for short periods of time; he essentially holds a price for a buyer
DMM also handles "Odd Lots"
DMM doesn't place odd lot orders on the book, rather he simply buys and sells these unites from its inventory charging current market price plus an odd lot differential
The Consolidated Tape
-Trades effected on the NYSE floor are reported by the sell side within 90 seconds
-OTC trades within 10 seconds
What does "s" mean on the consolidated ticker tape?
s=round lots of 100s
How many shares is a block?
What does "s/s" mean on the consolidated ticker tape?
Round lots of 10 shares; typically used for companies that are inactively traded
What does "SLD" mean on the consolidated ticker tape?
Out of sequence trade; this is not the current price
What does "s\OPD" mean on the consolidated ticker tape?
Opening delayed
Practice with Stop-Limit orders
Rule 76
Prohibits crossing of orders within a firm, if order to buy from customer A and order sell same security from customer B, security must first be offered in trading market at .01 point more than bid held by the firm
-if order is not taken, crossing may be performed
Rule 77
Prohibits person on the NYSE trading floor from
-betting on the course of the market
-buying or selling dividends
-buying or selling privileges to receive or deliver securities
-buying or selling securities at the close
-buying or selling securities at a stop price away from the current market
Rule 78
Prohibits prearranged trades to sell linked to a buy back at the same price
Rule 92
Requires customer orders receiving priority over firm's trading account
Rule 410
Requires that records of orders transmitted to the floor be kept for 3 years
Rule 411
States that if a trade is reported erroneously, the customer must pay the actual price of trade
Rule 435
Prohibits a member firm
-effecting trades of excessive frequency or excessive size
-effecting trades at successively higher or lower prices to create misleading appearance of trading actively
Where are most block trades handled?
OTC Block Trading desks
Long position versus short position
-All purchases are long
-Sales can be long or short
-Customer is only long to the extent of his net long position at a firm; net position is tallied if both positions are owned to determine if the customer is net long
Best Execution
Member firms are obligated to route customer orders to the trading market that allows for best execution
-If all markets have the same quote, the member is free to choose where an order will be routed and can accept "Payment for Order flow" as long as it is disclosed to customers
Rule 200 of Regulation SHO
-A short sale is the sale of the security that is borrowed
-every order must either be long on a sale or short on a sale
Rule 201 of Regulation SHO
If a stocks price drops by 10% or more from the previous days close, a circuit breaker is triggered for that security
-For the remainder of the day and entire next day, a short sale is only permitted at a price above the best bid for that security
-Applies to NMS stocks not OTCBB or Pink Sheet, or short sales
Rule 203 of Regulation SHO
Prior to effecting a short sale, short seller must locate the source from where the shares are to be borrowed; must have reasonable grounds to believe that the security can be borrowed and delivered on settlement
-Exchange must create a lost of hard to borrow securities known as "Threshold securities"
What happens if a seller fails to deliver a threshold security?
Must be bought no later than 10 business days, plus 3 for settlement
Circuit Breaker Rules
-2 levels of circuit breakers one effects the whole market and the other effects single stocks
Market Wide Circuit Breakers
-Applies to all NMS stocks
-If the level 1 or 2 drop occurs before 3:25 pm market closes for 15 minutes, if after market remains open.
-If level 3 drop occurs any time during the day, the market closes for the remainder of the day.
Level 1 drop
Level 2 Drop
Level 3 Drop
Tier 1 Stocks (Single stock circuit breakers)
Actively Traded stocks
-Trades that are 5% above or below the average price of the preceding 5 minute window are prohibited for stocks on S&P or Russell 100
Tier 2 Stocks (Single stock circuit breakers)
Less actively Traded Stocks
-Trades that are 10% above or below the average price of the preceding 5 minute window are prohibited for all other stocks
When was NASDAQ recognized as a stock exchange?
What are OTC stocks?
Those that cannot meet NASDAQ's listing standards and are quoted in display facilities
What aren't listed on exchanges?
-Corporate bonds
-Govt and agency debts
-Money Market Instruments
How do mutual funds work?
Sold as new issue OTC but do not trade.
OTC equity Markets
OTCBB and Pink Sheets
NASDAQ Global Market
Upper tier of NASDAQ
NASDAQ Capital Market
Lower tier of NASDAQ
The regulator for the OTC equities market and is completely separate from, and independent of the markets/exchanges
Levels are now incorporated into System
-Level 1 is a summary of the market intended for use by registered reps
-Level 2 lists all market makers and their quotes
Inside Market- NASDAQ Level 1
Defined by the highest bid and lowest ask
-the prices at which the next trades would take place
-Gives the inside market for the stock
Commissions and Mark Ups
-OTC and Exchange Agency Trades the commission is disclosed
-OTC Principal Transaction in NASDAQ stocks the markup is disclosed
-All other non-NASDAQ principal transactions the mark-up is not disclosed
NASDAQ Market Center-System
SYSTEM incorporates the Singlebook/Su[erMontage system which allowed fir the automated execution of NASDAQ trades along with a central limit order book
System Displays
For all NASDAQ securities limit orders that have not been executed, along with their size and price.
System Orders/Quotes/Features
-The orders are arranged on the Bid side (sequenced from high bid on down) and Ask side (sequenced from low ask on up)
-Orders are either for round lots OR odd lots and the market participant that enters the order shows under MPID
Anonymous quote
Renewing Quotes
-As each automatic execution occurs against the displayed quote, the size of the quote is reduced by the fill amount- termed "decrementation"
-Market makers are required to have a 2-sided bid-ask quote during regular market hours
What is the max order size in most systems?
What systems support the NASDAQ?
OATS and Act
Order Audit Trail System (OATS)
-Allows electronic capture of order information for NASDAQ equities, the reporting member must record the details of the order in OATS as to the immediate receipt or organization of any order
-Details any modification, cancellation or execution
Automated Confirmation Transaction (ACT)
Provides reporting and dissemination of last sale information on all equity and equity related issues traded OTC trades taking place in NASDAQ
-Third Market, OTCBB or Pink Sheet issues must be reported within 10 seconds of execution
Trade Reporting Facility- operates as part of ACT platform
Reports completed trades of NASDAQ issues
Reports completed trades of NYSE issues occurring OTC between 2 Third Market Makers
Over the Counter Reporting Facility (ORF)
Reports OTCBB and Pink Sheet Trades
Reports trades of NASDAQ and NYSE issues that occur on ECNs and ATSs
Mismatched Trades
-Once reporting party enters its record of the trade into the ACT the contra-party reviews the trade to accept or decline within 20 minutes to help minimize mismatched trades
Trade Reporting and Comparison System
-Reports trades of securities quoted in the ADF, then feeds to appropriate tape
Firm Quote
Dealer will honor this quote for stated size
Uniform Quote
Subject to negotiation
Bids Wanted
Dealer wanting to sell a position and is looking for a bidder
Offer Wanted
Dealer wanting to buy a position and is looking for a seller
Subject Quote
Quote is subject to confirmation; is an approximate price and can be changed.
Nominal Quote
Dealer's guess at the current price, but he's not willing to trade at that price
Workout Quote
Approximate quote; dealer has the work out exact price at which he will trade
Position Trading
Selling a security from inventory with a mark-up or buying a security into inventory with a mark-down
Diskless or Simultaneous Trading
After receiving a buy order form a customer, dealer then purchases stock into inventory and reseller it to customer
-Since dealer wan't holding security when order was received there's no risk to dealer
Simultaneously buying and selling short same security with different market makers to lock in temporary price differential
Agency Transaction
-if market order to buy and sell come in at the same time from two different customers for the same stock amount, it must be effected at the current market price and 2 commissions are earned
Dual Agency Transaction Trades
Agency Transaction
-Occur when customer directs you to sell one stock and use the proceeds to buy another; 2 commissions earned
Requirements of Transactions
Must find best available market in terms of
-Character of market for security
-size and type of transaction
-number of markets checked
-location and accessibility of broker-dealer to primary markets
How to find best available market for Non-NASDAQ stocks?
Get 3 quotes
No interpositioning
Meaning when firm gets an order to buy or sell, firm can't go through a middleman firm who turns into a market maker
Backing away
Cancelling a trade after it is accepted
Front Running
Trading ahead of a customer's order that's held
-PROHIBITED unless proper information barriers are up
Trading Ahead of Research
If firm's research will be issuing a report on a company that is likely to impact price, market makers cannot alter inventory position in anticipation of report
Trade Shredding
Practice of splitting a large order into multiple smaller ones to try and maximize monetary amount to be received
Trading Pools
Investors group together and "trade" stock to move up prices without actually changing ownership of stock
Wash Trades
Buying and selling to create the appearance of a trade
-known as painting the tape or a prearranged trade
Marking the Open/Close
Trading at the open or falsely reporting trades at the open just to affect the stock's opening price
Options Delistings
If stock is delisted, option is also delisted
-If option contracts of issuer are delisted, no new issues can be issued and existing contracts can trade until their expiration or exercised until expiration
What happens if stock stops trading?
Option does as well as there is no price to gauge option on
Floor Broker on CBOE
Executes trades on CBOE
-trades with another floor broker, a market maker or order book official and earns a fee
-DOES NOT hold inventory but can accept all orders and are obligated to find best available market
-Can cross orders if floor broker first requests bids and offers for those contracts from trading crowd
Market Makers
Individuals who trade for their own account in a security in which they're registered, cannot trade with public only with floor brokers
-Profits on spreads
-cannot be broker on same security
Registered Options Trader
Market maker who are also registered to trade options
Order Book Official (OBO)
If floor broker receives order than can't be executed at current market price, order can be given to order book official
-Exchange employee who works on a salary basis
-Cannot accept stop orders, only limit orders and others
Designated Primary Market Maker (DPM)
Similar to exchange DMM however unlike NYSE there are competing options market makers on floor
Order Priority
Public orders have priority if all entries are at same price, bids and asks displayed by order book official take priority
Spread and Straddle Orders
Orders entered on 1 ticket, if market order trades are executed at prevailing premium; if a limit order ticket specifies net debit or credit desired for spread or straddle
-Premium not specified to give leeway to both sides, must only satisfy net debit or credit
Spread Priority Rule
During the day spreading straddle limit orders have priority over single contract limit orders because it is easier to satisfy both sides of position
Accommodation Liquidation
For "worthless" options positions instead of letting the option expire worthless the contract is closed at $1 per contract
-Closing trade reported
-a.k.a. Cabinet Trades
Issuers cannot sell calls against?
their own stock
Order support system
-electronic trade execution system which speeds trading
Disclosure on Customer Accounts
Confirmation sent day after trade for regular way trades and that day for cash trades
What info is on a customer confirmation?
All relevant personal info as well as whether a payment for order flow was made
MSRB Customer Disclosure
Generally for munis quoted on yield basis, discount bonds are priced to maturity and premium are priced to near term call date
What is on Customer disclosure statement?
-How the securities are registered
-call or pre-refunding dates and the amount of the call or pre-refunding price
-if subject to federal or alt min tax
-if bonds are original issue discount
Fairness of Pricing to Customers
On exchanges all trades are agency trades and commissions are competitive
-In OTC market, trade can be effected on an Agency or Principal basis
-Mark ups must be fair and reasonable
Agency Basis
Order is matched with another party, commissions get charged
Principal Basis
Firm buys the stock into its inventory; mark-ups and downs are charged
FINRA 5% Policy
Applies to both OTC and exchange trades of non-exempt securities
-Commission GUIDELINE as well as mark-up/down GUIDELINE
Things considered in fairness of pricing
-Type of security
-Availability of the security
-Total dollar amount of the trade
-Price of the security
-Disclosure of the charges
-Pattern of mark-ups
-Nature of member's business
Where does a mark-up/down come from?
The inside market
Where does 5% policy not apply?
New issues and exempt securities
Where does 5% policy apply?
-Trades effected on the exchange floor
-NASDAQ Trades
-NASDAQ Agency Trades
-Riskless Trades
-Proceeds Transactions
MSRB Fair Pircing
Prices must be fair and reasonable
-Must exercise same care as they would with own account
- Fair price bears relationship to prevailing price
-Based on current market value AND reasonable compensation differs from fair pricing
Considered for Both principal and agency trades (MSRB)
-best judgement of fair market
-expense of executing order
-fact that firm is entitled to a profit
-availability of security
-Total dollar amount of transaction
Regular Way Settlement Date
Regular way Govts and Options Settlement Date
Next Day
Cash Settlement Date
Same day
Seller's Option Settlement Date
Used if more than 3 business days are needed to deliver; delivery cannot occur earlier than 4th business day
When, As, and if Issued
Used for new issues whose issuance is announced, but the certificates aren't yet available for trading
Comparisons and DK Notices
On day of trade, comparisons are sent to contra broker to ascertain that all terms are agreed upon and that settlement can proceed
Contra Broker
Broker on the otherside of the trade
DK Notice
Don't Know Notice
-These are required to be resolved within 20 minutes of receiving a mismatched trading report
Good Delivery of Securities
On settlement securities are delivered and paid for, if not in good form they can be rejected and settlement will not take place
signature in the exact name printed on the certificate
Stock or Bond Power
signed receipt which transfers ownership of stock or bond
-signature guaranteed by commercial bank or NYSE firm
Stock Delivery
ONLY in round lots of 100 shares
EX. 8 certificates of 50 shares not acceptable
Municipal Delivery
Delivered with legal opinion and if insured, proof of insurance
Due Bills and Due Bill Checks
If dividend is accidentally mailed to seller, your firm will send a due bill to contra broker to claim dividend, he sends back due bill check.
Securities are delivered to a brokerage firm upon settlement and are refused for a valid reason
When a brokerage firm accepts delivery and later determines delivery wasn't good