For anyone who has gone to Disney World and used a Disney Fastpass, it truly changes the Disney experience. A Fastpass holder can bypass the main line and instead use the much shorter “Fastpass” line, where the waits are often just a few minutes instead of hours at the most popular rides.[1] Everyone wins – Disney makes an extra profit and the Fastpassers get to jump ahead on popular rides. Well, everyone except, of course, the non-Fastpass riders who are now facing an even longer wait.
The NYSE D-quote has a similar vibe to it, as it provides the similar access to the NYSE closing auction, but without the restrictions applied to traditional MOC/LOC orders. Specifically, traders using MOC/LOC orders must send them in no later than 3:50PM, the (new) NYSE cutoff time. After 3:50PM, MOC/LOC orders can be sent only if there is a sizeable imbalance, in which case they are allowed to send offsetting orders only. For example, if a large buy imbalance exists after 3:50PM, traders may submit on-close sell orders, but not buy orders. Also, after the cutoff, MOC/LOC orders cannot be canceled, except for certain error scenarios.
Contrast this with the D-quote, which basically has none of these restrictions. D-quotes can be sent up until 3:59:50 PM, ten seconds before the close, regardless of the direction of the trade or whether an imbalance exists. So, D-quotes can be used even if they add to a large existing imbalance, create a large imbalance that otherwise wouldn’t exist, or even flip the direction of the imbalance (from buy to sell, for example). And what’s more, D-quotes can be canceled up until 3:59:50 PM. The wrinkle that prevents D-quotes from being a perfect substitute for an unrestricted MOC/LOC order is that a floor broker must submit the D-quote into the auction. Specifically, buyside orders must be routed to an NYSE floor broker, who then manually releases them to the closing auction.
The benefits of the D-quote
The purpose of this blog is to discuss how the D-quote can be useful to buyside traders – and how it could be potentially harmful. Perhaps the biggest benefit of the D-quote is that it can be a great way – and often the only way – to access the NYSE closing auction after the 3:50 PM cutoff. For traders or PMs who simply missed the 3:50 PM cutoff, the D-quote can be a godsend, especially for relatively small, impact-less orders. Furthermore, some algo providers have even incorporated D-quotes into their algorithms, which allows traders to cancel their algorithmic orders after 3:50 PM, without the closing MOC slice getting “stuck” in the NYSE auction. The D-quote therefore provides more flexibility, albeit at potentially higher costs and increased operational complexity.
Another potential benefit of the D-quote is that it allows traders to work their order into the market for a longer period of time before their on-close interest is revealed to the market. Unlike the MOC/LOC interest which is first announced at 3:50 PM, the D-quote interest is not incorporated into the feed until 3:55PM. This is important because the market responds to auction imbalances at the time they are announced via the imbalance feeds.[2] This gives the D-quote user an extra 5 minutes to trade in the open market before any imbalance they may have created (or exacerbated) moves prices adversely at the 3:55PM announcement.
Note that prior to the NYSE changing its cutoff time from 3:45 PM to 3:50 PM, a trader using a D-quote to access the auction would have had 10 extra minutes to trade in the open market before their trading D-quote interest was revealed. Consequently, the new MOC/LOC cutoff time decreases the relative value of the D-quote since it both reduces the probability that a trader will miss the MOC/LOC deadline and shortens the amount of time between the initial MOC/LOC imbalance announcement and the time when the D-quote interest is first incorporated in the imbalance information, from ten minutes to five minutes.
The Risks of the D-quote
Despite the benefits of the D-quote, it is by no means a silver bullet. First, if a trader creates an imbalance when using a D-quote, the market only learns of it at 3:55PM, when the D-quote interest is incorporated in the publicly disseminated feed. While this may help the trader as noted above, it can also work against her, as this late announcement gives the market only 5 minutes (at most) to allow offsetting orders to arrive in the market. Plus, because of the constraints placed on MOC/LOC orders by the NYSE, the means by which any D-quote-driven imbalance can be offset is limited.
Specifically, there are three ways to offset a D-quote-driven imbalance: 1) other traders can submit offsetting D-quotes, 2) imbalance-only orders could be used, or 3) traders could send offsetting MOC/LOC orders, but only if a large imbalance in the direction of the trade already exists. For example, for (3), on-close sell orders would be allowed only if a large buy imbalance already existed, which is hardly a great scenario since in that case, the D-quotes actually increased an existing imbalance. In sum, then, the short time and limited means available to offset an imbalance could substantially increase the impact costs of large D-quotes, relative to comparable MOC/LOC orders submitted before the cutoff. And in fact, empirical evidence supports this, i.e., D-quotes have been found to have greater market impact than comparable MOC orders.[3]
The second potential issue is the D-quote adds operational complexity relative to a traditional MOC/LOC orders. The D-quote involves an extra “hop” into the closing auction, as the order must first be routed to a floor broker, who must then “manually” release it to the closing auction. In other words, the D-quote is not a simple electronic passthrough. Rather, the floor broker must take manual action before D-quotes can make their way into the auction.
While this adds another potential check, as noted above, the human factor can cut both ways. The floor brokers themselves could create errors or mistakenly allow disruptive orders into the market, orders which could have been prevented by other means. Similarly, if the floor broker does not accept the order prior to the D-quote deadline, due to slowness in the floor broker’s system, inattentiveness, etc., the order will simply not make it into the auction[4]. For these reasons, a buyside trader (or their executing broker if accessing D-quotes indirectly) must have a well-defined service level agreement with their floor brokers regarding who is responsible should, say, a D-quote order not make it into the closing auction.
Takeaways
The NYSE D-quote provides an effective way to access the auction should a trader miss the deadline for any reason. But the trader should not view D-quotes as a costless, riskless way to avoid the MOC/LOC constraints. A large D-quote order may create an imbalance that the market cannot offset efficiently, given the late release of D-quote imbalance information and the limits on MOC/LOC trading after 3:50PM. Plus, the manual nature of D-quotes increases operational complexity and risk. For traders who simply missed the deadline for submitting a small, impact-less order, D-quotes could be a great way to access the auction. But otherwise, traders should think carefully about whether such late participation is worth the potential increased risk and cost.
In addition, the D-quote raises some interesting questions from a market structure perspective. For example, some would ask why the NYSE imposes so many restrictions on MOC/LOC orders when they can be bypassed almost entirely via D-quotes. Put another way, if these rules are so helpful in maintaining an orderly close, why does the NYSE allow traders to bypass them simply by routing via a floor broker? While some would argue that the “manual” nature of the D-quote allows for an additional check on late-arriving orders, others would argue that having humans in the loop could actually increase the possibility for errors. Not to mention fully automated auctions have been run successfully by other markets, most notably the Nasdaq – and the NYSE’s own Arca exchange.
Nevertheless, the fact that traders still bias toward traditional MOC/LOC orders suggests that perhaps traders don’t see much incremental benefit to choosing D-quotes over MOC/LOC orders, and they may possibly prefer to avoid the potential risks associated with D-quotes. Or it could be that the increased direct costs of paying floor brokers preclude some cost-sensitive traders from taking advantage of the D-quote option, leaving them feeling like that sad family made to stand in line for hours to ride Space Mountain, while the privileged Fastpass holders march ahead of them (in colored smocks and numbered name tags).
The author is the Founder and President of The Bacidore Group, LLC. For more information on how the Bacidore Group can help improve trading performance as well as measure that performance, please feel free to contact us at info@bacidore.com or via our webpage www.bacidore.com.
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[1] The Fastpass service is available at no cost to all ticket holders. However, certain customers get “time priority” in selecting their rides. For example, staying at a Disney Resort allows a guest to select their Fastpass rides up to 60 days in advance, allowing them first crack at the limited number of passes available for the most popular rides. Consequently, many guests are unable to use their Fastpasses on the popular rides, and must therefore wait on the much longer “regular” lines instead.
[2] See Bacidore, Xu, and Yang, 2013, “Trading around the Close”, Journal of Trading, Vol. 8(1), pp. 48-57.
[3] See Bacidore, Polidore, and Xu, 2014, “The Cost of the D-quote”, Journal of Trading, Volume 9 (2), pp. 39-42.
[4] Floor brokers have tools that allow them to accept batches of hundreds of orders at a time to simply the workflow. However, critics would argue that such tools call into question whether floor brokers are really evaluating each individual order before routing them into the auction.