.
Trade

The Evolution of NASDAQ OMX PSX: Bringing Pro Rata Allocation to the Electronic Markets .

Markets around the world have used different ways to allocate goods to buyers or in the case of securities, allocating shares to liquidity providers. One such method is called pro rata.

The Evolution of NASDAQ OMX PSX: Bringing Pro Rata Allocation to the Electronic Markets

By Chuck Mack / Deputy Head of Product and Business Development for U.S. Equities

Markets around the world have used different ways to allocate goods to buyers or in the case of securities, allocating shares to liquidity providers.  One such method is called pro rata.  A pro rata allocation divides an order among liquidity providers based on the size they are displaying as their quote as a percentage of the total size displayed at that price.  In this sense, the allocation method rewards liquidity providers who are willing to display a larger quote size. Below is an example of pro rata allocation.

Chart of Evolution of Nasdaq PSX

The concept of dividing securities executions among quotes and orders at the same price based on a pro rata allocation has existed for some time.  For example, traditional floor-based options exchanges in the U.S. have used pro rata concepts for years and some continue today.

Currently, U.S. equities trading is generally done via a price-time allocation – meaning the first order or quote at a price gets filled (or executed) before an order that was received later at that same price.

In 2010, NASDAQ OMX launched a pro rata exchange – NASDAQ OMX PSX (PSX). One of the challenges that PSX ran into was price-flickering.  As dealers constantly updated their quoted size in reaction to other dealer updates, their quotes came in and out of the market fairly constantly and repetitively.

This created frustration for market participants who were attempting to access these quotations. The participants got the sense that they could never tell whether or not a quote on PSX was stable and thus, began looking elsewhere for liquidity.

In 2012, PSX joined the other exchanges and became a price/time priority exchange. Shortly thereafter, some new thinking came to light — what if price/time and pro rata were combined somehow so you could have both quote stability and large displayed size at the quote?  This is not a completely new idea; other markets around the world have variations of this concept, including some options exchanges in the U.S., but it is not in use on any U.S. equities exchanges.

Thus, the current PSX Price Setter Pro Rata model was born and subsequently launched in August 1, 2014.  On PSX, the first order or quote at a price is guaranteed a minimum allocation (40%) and all other quotes share in the allocation of incoming orders.

PSX thus rewards aggressive liquidity providers that set the best price on PSX, thereby narrowing spreads for seekers of liquidity (liquidity seekers are often institutions such as mutual fund portfolio managers or individual retail investors), while also rewarding other liquidity providers for joining that price with size.

In theory, PSX provides a way for participants to compete on price without having to race to be first, while also recognizing the value a price setter brings to the market.

To learn more about PSX and the pro rata execution model, visit www.nasdaqomxtrader.com/PSX


Chuck Mack is the Deputy Head of Product and Business Development for U.S. Equities.
TAGS: Trading
Recent posts{{catTitle ? " in " + catTitle : ""}}
{{post.Date | date:'MMM d'}}
Scroll up