Sunday, January 07, 2007

Odd Lot Trades Generate Controversy

A couple of weeks ago, in response to a query I ran in my “Electronic Investor” column in Barron’s, a reader asked me what was going on with Interactive Brokers’ odd lot trading capabilities. 

On December 28 he told me, “Roughly a month ago, Interactive Brokers disabled all trading in odd lots - non 100 share multiples.  They did this suddenly and without any warning (that I was aware of).  Within a couple of days they re-enabled odd lot trading, again without explanation.

“Do you have any idea why they are wanting to do this or if it’s an industry trend?  My strategies happen to employ heavy odd lot trading.  Others might be interested in this topic.”

I contacted Steve Sanders at Interactive Brokers and asked him what was going on.  His response was interesting as it illustrated ways that savvy traders are using regulations to their benefit.  Sanders says that the odd lot trading issue is an exchange issue, not an IB issue, but because of the firm’s large proportion of extremely savvy traders, the exchanges tend to land hard on IB when they feel the firm is stretching the rules. 

Sanders says that the exchanges do not like odd lot orders because there is a rule that all odd lot orders on the books of an exchange must be filled at the next printed price, which is the price a regular lot order most recently received.  Odd lot orders are restricted from moving the market price.  A customer with a large block trade of 10,000 might split an order into small amounts of 90 shares, each of which would get filled at the next printed price.  What usually happens when a large block hits the market is that it moves the market price up (if the customer is buying) or down (if the customer is selling), just because of the volume.  So an order for 10,000 shares would, in all probability, be filled at a price which is worse than the next print.

Sanders goes on to say, “Because IB has very savvy traders that took advantage of the odd lot rule, the NYSE complained to us years ago about our customer’s odd lot trading habits, and we were asked to curtail odd lot trading on the NYSE for opening orders.  This has been in effect for years.  With Reg NMS on the horizon, the NASD sent us a memo saying that we had to comply with all NYSE rules including the odd lot rule.  Our plan was to implement the same logic as we have been using for the NYSE for years.  An overzealous programmer released the programming change before we had a chance to send notification to our customers.  When we started to get calls from customers complaining, we reversed the new logic.  We normally provide our customers with immediate communication on all changes and unfortunately this change slipped through the cracks.”

Sanders says that IB will try to remedy the problem with an alternative approach with the NASD, given the complaints we received from customers on the new logic.  He says, “If we suspect certain customers of breaking large trades into odd lots in order to receive superior price execution, we will contact the customer to stop, and suspend trading if our warnings do not work.” IB management is hoping this remedy will satisfy the NASD, but if not, the firm may have to do more. 

Further requirements will be determined by the NASD and Sanders plans to give IB customers advance warning if further changes need to be made.

Posted by twcarey on 01/07 at 09:47 AM
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