Why don't lowest prices always win?

Hypothetical situation:

PM at fidelity is looking to dump 500k of ibm.
trader at fidelity gets the order, calls the sellside salesmen. His usual counterparty at GS has a 60.01 bid. Another sales-trader at MS has a 60.04 bid.
Why would the fidelity saleman ever execute the deal with GS, essenitally donating .03x500k = $15,000 to GS? Yes, he has an established relationship but does he honestly expect a reputable desk at MS to somehow screw him?

Generally, why don't the most competitive prices always win out?

 

at the risk of being wrong, I will tell what would happen:

that would be illegal. for a nyse stock like ibm, the trader is required to fill all limit orders on the book at a better price first before filling in a client such as GS.

 

Although I can't comment on your particular case, there are definite times when something like this could happen: suppose one shop has been giving better bids rather consistently on a product--then, as a trader, you don't want to give that shop the indication that they're outside of the market. As a result, you'll often eat a $15,000 loss, in order to make continue to get favorable bids (this happens more when the market is especially volatile). This is likely to happen is when a PM at a big pension fund is going overweight to underweight a sector--the algo traders have to determine prices, so a portfolio manager won't want to go to the same trader all the time. Also, for courtesy trades, like swap unwinds, etc. in medium/low liquidity environments, some banks are more courteous than others (ie. have modeled liquidity premiums or reset risks differently).

 
Best Response

This kind of stuff can happen all the time for many different reasons. It could be the case that GS took the PM out for nice dinner the night before and bought $1000 bottle of wine so the PM the next day picks up the phone to place an order with GS. The more likely scenario is one where fidelity is trying to pay each back a certain amount of commissions each quarter based on how much value they think they are getting from the firm. This value could be better ideas, better research, better prime brokerage, larger allotment of IPO shares, or more deal flow from investment banking. At the end of each quarter or year each firm is going to see how their commissions from fidelity stack up against other firms. It may just be the case that when it is time to sell $500k of IBM Fidelity wants to reward Goldman with more commissions.

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well as a disclaimer I dont know equity trading that well.

in your example I'd think they'd almost definitely go with the lower price. a few reasons someone might not

1) the dealer has brought an idea to them, so they trade with the dealer based on that. if the price is out of line, this may not hold 2) there is some other relationship reason

either way in vanilla equities, i'd think price would win every time....

 

One thing in equities that you have to realize is that they are constantly moving. I am going to ask a trader on the buy side this question because I think its an interesting.

The facts.

Fidelity wants to sell 500k IBM. MS is best bid at 60.04 X 500K GS is bidding 60.01 X 500K

I am not sure but my logical guess could be speed of market. if the buy side trader has to get MS on the phone and the stock is falling by the time they are on the phone MS may not honor the quote for the full 500K and they would have been better off eating the .03 going with goldman. The larger the quantity the more speed becomes a factor. With the information given this is a difficult question to answer. Sure MS most likely are going to give a partial @ 60.04 if thats when the call began. You guys have to remember that equities are highly liquid and constantly moving in price. Speed and execution are a skill. The way this gets executed makes this convoluted. Is this electronic vs voice vs Floor.

I will present this question to a buy side trader I know.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.
 

Well i'd assume if you have 500k shares of ibm to trade, the guy will give you the price verbally, ie you have guys calling into both desks and showing a price in simulatneously. then you hit the better bid.

whenever you're in comp, you get on the phone with the custie. i try to avoid comp business :-)

and as to this

"MS may not honor the quote for the full 500K "

if you show a price for 500k, you must honor it. that's why size is specified.

 

was unsure if he meant 60.04 for the entire quantity. Yeah i would suppose that if on the phone with both dealers best price should always win as you have said before jimbo. Price is usually what matters the most. These questions are good they make you think.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.
 

"was unsure if he meant 60.04 for the entire quantity."

i think you specify price for the full amount. i know this is hypothetical, but 500k shares of IBM doesnt seem like a particularly large amount. certainly a dealer can make an aggressive price in that...

market sizes in the swaps market can easily reach the billions. market size in cms spread options start at $250mm.

 

Before I digress I must reiterate that I have no experience in trading on a desk this is all pure speculation on my part as to how I believe things may work. If anyone here can clear up the questions by all means clear up the confusion.

Everyone bashes equities for their lack of spreads. Well thats where people tend to forget that the relative size that you can move at the inside market is small. The Notional value for 500k IBM is just over $50mm peanuts compared to fixed income or FX. While IBM might have a tight spread on the inside market you have to realize you cannot move substantial quantity at the inside market. What you have to consider is the spread on the entire quantity. This is what people forget and possibly why equities gets a bad rap.

IBM has a average daily volume over the past 3 months at just over 9mm a day. There are 390 trading minutes in a day, so that comes out to about 20k shares per minute for a notional value of $2mm on average. Again this shows how small individual equities are compared to fixed income or FX. I am not sure what the conventions are in equities in terms of the way a trader quotes a price on the entire quantity or if they auction off bits and pieces at a time. Based on my experience of watching the tape it appears that they tend to auction off parts at a time. You have no idea how moving a massive amount of stock may impact the market. The worst thing a trader wants to do is get jammed because he priced it wrong. However; I assume that both methods are used. I am also aware that ideally the trader gets to work the order.

Food for thought, I wish they taught this stuff in school I actually would enjoy studying...

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.
 

This is an old thread but I thought that I would answer the question since I'm bored and it was never answered correctly.

Your hypothetical situation could never occur. In cash equities, banks are paid by commission. The bank gets x cents for every share traded. Commissions are negotiated prior to trading and are pretty standard across banks. Equity traders buy or sell stocks at the market price. So if an MS equity trader sees a 60.01 price at a single point in time, the GS equity trader will see a 60.01 price at the same point in time. However, equity prices move quickly and all of the shares in the order can't be purchased or sold at the same time. When equity traders are instructed to work an order, the skill comes in deciding the best time to execute the trade and the amount of shares that can be traded without moving the price too much.

Large buyside funds decide how many orders to give to each bank based on voting. PMs, analysts, and traders will cast their votes based on their relationships with the sales trader and based on their use of the equity research. Equity trading is usually the method of payment for use of research. Successful analysis and calls by the research analysts will lead to more business.

 

So illegal. It's a form of front-running. Selling a sizeable order cheaper, could effect the current trading market on the security. Hence, if the martket is 60.04-60.05, you sell it for 60.01, dropping the market to probably 60-60.01. Orders have to be executed on the market, not outside of it. Customers are suppose to get the best fill possible.

 

Unrelated noob question, I didn't want to start a new thread: is it common for people in S&T to go to business school? (obviously they will if they want to change careers, I don't mean that) And If so, for what reason?

 

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