Trade Commission regulation?
Hi everyone,
I have a really amateur question about trade commission that I was hoping that someone here can help me answer.
My question is: What prevents a trader from buying a huge quantity of security from the exclusive security inventory of the issuer or market maker (e.g. UBS), and reselling them to retail customer with a big markup? I know there must be some regulations involved, but how do traders make money if this method of buying low and selling high is not permitted?
Thanks!
i don't understand the question, you mean buying a huge block of stock or something?
uh, efficient markets pretty much stop this. any account that would be stupid enough to get ripped off in a way that would violate some kind of "fair play" regulations tend to not last very long. this pretty much would probably only be possible in structured products, and rest assured that accounts most certainly shop around. it would probably be impossible (and suicidal to your franchise) to get away with outright gouging a a client. people talk, and aren't stupid. it would be very difficult to execute a trade like that when the account looking to buy looks around and sees other trades vastly cheaper.
Do traders only make money based on % commission on quantity of security then? If they're offering securities from their own capital markets, would they be able to set their own offer price? or are they still in competition with everyone else to offer the lowest price?
uhh, certain firms are NOTORIOUS for front running their clients.
i'm not saying it doesn't happen ever, i'm just saying that most of the time people know what the proper price level is. over-priced sales do happen, but not really to the point where just the price difference alone (not doing something procedurally illegal like front-running) raises a red flag.
as for $ traders make, it depends on security and transaction. every pretty much takes prop bets, flow traders make bid/ask spread, structured products guys arb collateral vs. product, etc. brokers make "commission".
" i'm just saying that most of the time people know what the proper price level is."
not in exotics land. not at all.
wrong, you're still going to see similar structures trade within each other, and if there are price differences, they're typically due to someone's term model on a swaption or prepayment model on a CDO predicting something drastically different.
"wrong, you're still going to see similar structures trade within each other, and if there are price differences, they're typically due to someone's term model on a swaption"
No. First of all swaptions are a vanilla instrument and are widely quoted and traded. You are very unlikely to see price divergence in any atm swaptions.
If you ask a variety of dealers for a decently out of the money spread option (which is one of the most basic exotics) you will get radically different prices. the things never trade, and no one knows where they should be exactly. hedge funds love to play the 'pick off a dealer' game. I've seen quotes on structures where some prices are double or triple the others. Try finding a price on a 5 yr curve cap on 10s-2s struck at 125 or 150 for instance.
The difference gets even more pronounced when a complex structure is brought to the market for the first time...the level it prints at the first time can be very, very different from where it prints the second time.
what do you trade, liquidity?
Jimbo
i think you're proving my point. the question is whether or not you can rip someone off just by pure ignorance, i.e. crossing securities at huge spreads of something that is vanilla.
let's look at what you picked as your example: a very out-of-the-money option that never trades. i just said that if there are huge price differences, it's a VALUATION issue, not that someone doesn't know who's offering what structure at what level. hmm... illiquid out-of-the-money stuff that doesn't trade has huge price differences, while the at-the-money swaptions that they run THROUGH THE SAME MODEL as the first option all trade at the same level. i'm a CMO/ABS trader, so let me draw a comparative exampl with an area i know. Current coupon Agency CMOs? 3bp markets, pretty much no matter what the structure. Seasoned premium passthrough CMOs, say like a 9% GN2 100wala bond? Prices will go from 102-00 all the way to 107-00, since everyone runs it through an OAS model to determine where they care and this model overweights seasoning, and that model overweights loan balance, etc. They trade rarely, and hence no reasonable trader can look at their model and calibrate it to where stuff trades. When someone puts them out for the bid, bids are all over the place. Same thing with your example: nobody knows what's the fair level for your illiquid trades because IT DOESN'T TRADE. Take a look at mortgage derivatives: trust IOs and POs are super leveraged towards prepayments and are heavily driven by prepay models, and yet they still trade at tight markets.
so you're actually just demonstrating what i'm trying to get at: if there is a huge price difference, it's because it's a valuation/modeling issue, not a ripoff issue. even the exotic stuff that no one knows for sure what it's worth trades at efficient markets given enough people trading them actively. i mean why do you think one-of-a-kind structured credit products actually make money? you will not and cannot find any kind of product that is traded actively that results in any kind of massive ripoff.
i take it you're a vol trader Jimbo?
trade rates.
the models are different for swaptions than for the more exotic stuff. there are lots of models being used in my market now, it's really not that standardized. so price divergence occurs based differing views of model, and the first time a structure is brought to market, the customer can get absolutely jacked b/c no one has seen it before.
"you will not and cannot find any kind of product that is traded actively that results in any kind of massive ripoff."
unless it's sold into retail.
What kind of market do you see for these kind of exotics? most is OTC if I'm not mistaken. I know for low liquidity markets like deferred commodities, commercials like to execute swaptions OTC so they don't move the market.
Do you guys actually put on these far out-of-the money trades? Unless you are a big player and need to hedge, I don't see why you would get involved.
"What kind of market do you see for these kind of exotics? most is OTC if I'm not mistaken. I know for low liquidity markets like deferred commodities, commercials like to execute swaptions OTC so they don't move the market.
Do you guys actually put on these far out-of-the money trades? Unless you are a big player and need to hedge, I don't see why you would get involved "
Lots of overseas investors love this stuff...not necessarily a business need, just take a punt and trying to juice returns.
and yes it's all otc.
also, let me clarify - when i say massive ripoff, i mean ripoff like compliance calls you up and asks you wtf you're doing, not as in you sold something above market. i'm talking 8%, 10%, 12% ripoffs. jimbo what's your view on 2s-10s?
steeper. you?
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