On Jan. 13, Durango, Colo.-based OptiMark Technologies and Nasdaq inked an agreement in principle to integrate OptiMark's supercomputer-driven matching system with the Nasdaq Stock Market. But first the plan must be approved by the Securities and Exchange Commission. OptiMark, of course, is not short of ambition, aiming to allow institutions and retail customers to trade anonymously and without disclosure, based on price, size and satisfaction levels.
OptiMark's chairman and chief executive is Bill Lupien, former head of Instinet and previously a specialist for 17 years on the Pacific Exchange (PCX). He co-invented OptiMark with John "Terry" Rickard, who is the company president.
Here, Lupien answers some questions on traders' minds.
Q: Your agreement with Nasdaq is big news.
A: Well, we have always recognized the need to provide investors with a way to trade over-the-counter as well as listed equities. So it was natural for us to approach Nasdaq, as the primary market in OTC stocks, to discuss offering OptiMark to National Association of Securities Dealers' members.
We were pleased when Nasdaq indicated not only an interest in making OptiMark a facility of Nasdaq, but expressed a desire in integratating OptiMark with its planned limit-order file. By increasing liquidity, the integration of OptiMark with Nasdaq will make trading OTC stocks more efficient and less costly for institutional investors.
In addition, brokers representing small investors will be able to use OptiMark to give their retail customers access to the better prices frequently offered by institutional investors something they cannot readily do today. For OptiMark, the agreement in principle with Nasdaq, the largest and fastest growing electronic market in the world, provides a level of credibility that will continue to attract buy-side and sell-side users.
Q: What inspired you to develop OptiMark ?
A: We were looking for a comprehensive solution to a pervasive problem plaguing the securities industry: how to find liquidity at a reasonable cost.
The structural deficiencies of the securities market primary among them, information leakage have forced traders to withhold liquidity in order to avoid giving the market information that might cause prices to move against them. Such adverse price moves typically associated with large orders and referred to as market impact and the inefficient strategies that traders use to avoid them, cost investors billions of dollars annually.
The problem has been getting worse every year, as more and more assets are concentrated in mutual funds and pension funds.
Q: So what exactly is OptiMark?
A: OptiMark is an optimal, supercomputer-driven, trade-matching mechanism with features to satisfy the trading desires of all market participants, from small retail investors to large institutional investors.
OptiMark incorporates two powerful, patented features. First, it allows the anonymous and non-disclosed representation of a trader's willingness to trade over a continuous range of prices and sizes. Second, it provides a means of optimizing the sequential allocation of trades between buyers and sellers at different prices and sizes based upon a measure of mutual willingness to trade and a deterministic set of trading rules. Additionally, order entry and cancellation can be accomplished at electronic speeds over a 100 percent FIX-compliant transaction network. OptiMark will function as a frequent – that is, every 90 seconds – multi-price call market.
Q: How much will OptiMark cost users?
A: OptiMark charges a penny a share to the clearing broker for completed trades, a transaction fee comparable to floor brokerage. There is no charge to the desk for installation or maintenance. The only other cost is the modest effort required to learn how to use a powerful new tool, a cost that will be paid back many times over in reduced market-impact costs.
OptiMark will be a facility of Nasdaq for trading OTC stocks, just as it is a facility of the PCX for listed stocks. As is the case with the PCX, we expect Nasdaq to charge its members approximately a penny for each share transacted through the OptiMark-Nasdaq facility. Market makers will receive a discount. Currently, the PCX has set its fee at a penny per side, for each share transacted through OptiMark.
Nasdaq will pay OptiMark on a share-transacted basis for operating the facility. Similarly, the PCX will pay OptiMark a fee for operating the facility. Non-PCX member users, namely institutional investors, will pay their brokers a commission at a rate they negotiate with their brokers.
Q: Explain how OptiMark-generated orders are entered and canceled at electronic speeds over a FIX-compliant network?
A: OptiMark, with a messaging format that operates as an extension of FIX, will be accessible through a wide range of gateways, including its own 56 k/bps FIX-compliant transaction network. Thus, any order-management system that can route trades through a FIX-compliant interface can route them easily to OptiMark. Likewise with cancellations.
Q: Won't a call market running every 90 seconds stretch the human capacity of individual traders?
A: The methodology for creating OptiMark profiles is extremely user-friendly and designed for speed. A wide array of templates are resident on the system for representing and customizing commonly-employed strategies. In addition, profiles placed in OptiMark will remain in force from one call-cycle to the next, unless they are withdrawn. They may also be pegged to certain underlying variables, indices for example, so that adjustments to the auction market are made automatically. This methodology, versus the effort required today, can actually lessen the workload.
Q: What about market participants representing their full trading interest with satisfaction profiles. Creating such profiles surely will stretch human capacity?
A: In many cases, a profile equates to a conventional limit order or a limit order with discretion, and can be entered with the same effort. To facilitate rapid entry, the system includes custom templates for automatically creating complex profiles to represent frequently-used strategies. Such profiles can often replace the laborious task of entering multiple individual orders. OptiMark requires no more effort than today's trade order-management systems, and is easier than the use of most DOT systems.
Q: Fine, but suppose a trader with 100 stocks on his blotter selects 25 to go into OptiMark. Perhaps he'll buy 100,000 shares here and a million shares there, and do that 25 times over. The trading day is roughly 7 hours long, or 420 minutes multiplied by 60 seconds. Divide that by 90 seconds for every call and that comes to 280 calls. Isn't that a lot of exposures to follow in one day?
A: Those 280 daily calls actually mean 280 breaks, each more than a minute long, when a trader doesn't have to follow the matches. This method is much less burdensome than watching every tick in a continuous market.
Q: If negative news hits the market, a trader may want to withdraw his order.
A: A trader can cancel any or all of his orders virtually instantaneously in OptiMark without any manual intervention, as is required for exchange orders. In addition, order cancellation in OptiMark has advantages over orders canceled in a continuous market. For example, in OptiMark, the existence of an order is unknown, and is not executable until the next match occurs. OptiMark is also customizable, able to accommodate many third-party and user-created programs designed to deal with special situations, such as auto cancel in the event of news.
Q: If a user enters a buy profile and nothing gets done, can't the user reasonably assume there are no sellers at his stated level?
A: Yes
Q: What protection do institutional customers have when a seller goes into OptiMark, clears out all the bids on XYZ stock buying it down a point and then offers the stock back to institutions that may have previously bought the stock at the higher price?
A: If we assume that it's a seller clearing out the bids, then the buy-side institutions represented in OptiMark will have paid whatever the down-a-point price was, which would seem at least temporarily advantageous and not in need of protection.
If the other institutions' orders are exposed by being part of the disseminated quote, they will have an opportunity to participate in the OptiMark print by being sent an Intermarket Trading System (ITS) commitment to trade at the print price for whatever size is shown.
Q: How does OptiMark facilitate price discovery?
A: Users can employ the system's order-representation capability to indicate the price they are willing to pay or accept at a variety of size points, including the largest quantities they may wish to buy or sell, and not just at the retail-size points they now typically disclose. The system's matching algorithm determines the prices and sizes at which buying and selling interest overlap, thus discovering market-price for an instrument during every matching cycle or periodic call.
Q: Can users get price improvement?
A: Yes. OptiMark searches for optimal matches, based upon both mutual satisfaction and a set of priority rules. Within a totally secure environment, it enables a large-size trade to interact with all contra-trading interest at once, avoiding the serial leakage of information and resulting market impact involved in executing such a trade in small pieces.
OptiMark also takes retail interest and aggregates it whenever possible to satisfy institutional interest, and this uniquely allows the small investor a chance at price improvement against a more aggressively priced institutional order.
Q: If OptiMark is successful, won't it be difficult to see prices?
A: As in today's market, bid and ask prices for immediately executable orders will be displayed in the continuous exchange-based market, and the prices and sizes of all trades, including those that have been matched in OptiMark's periodic call market, will be printed on the exchange ticker.
Q: Let's turn to non-disclosure and anonymity. Do institutions surrender non-disclosure as soon they send trades to clearing brokers for settlement?
A: Users have the option of selecting immediate or end-of-day broker notifications for their OptiMark transactions. These options will prove adequate for a wide range of users and trading strategies. In addition, users may designate anonymity brokers for clearing and settlement of their OptiMark transactions, ensuring end-to-day anonymity and non-disclosure.
Q: How does an institution using OptiMark avoid giving a broker information about its intentions?
A: In OptiMark, institutions can trade directly with each other, and the broker is informed of the results only at the end of the day if a trade is completed.
Q: Say an institution is selling 75,000 shares of XYZ. Could the institutions' clearing broker ascertain that the institution has a larger order behind this trade from public filings?
A: Public filings are too outdated to be a meaningful factor in most trading. Value players who hold positions have it a bit tougher, but the markets typically move faster than the information. And of course disclosure of who a trade is for on a trading floor itself is prohibited. In addition, brokers have the ability to extend the anonymity period beyond the trade date. Sensitive orders may flow to those that offer such a service.
Q: What exactly is the role of the PCX?
A: The PCX will offer OptiMark to investors through members as a facility of the exchange. The relationship is non-exclusive.
Continuous trading on the PCX and any other exchange that offers OptiMark in the future will operate as before. OptiMark is fully integrated with the National Market System (NMS) through the PCX's participation in the ITS.
Q: How is OptiMark different from other electronic trading systems?
A: In a nutshell, the system uniquely combines satisfaction, anonymity, non-disclosure, price discovery, instant ingress/egress and optimal execution.
OptiMark is the only system that enables market participants to represent their full trading interest with certified confidentiality, in a completely anonymous and non-disclosed manner. By anonymity, we mean you don't know who is doing whatever in the market. By non-disclosure, we mean you don't know what the market participant is doing, or trying to do.
OptiMark also allows expression of trading interest across a range of prices and sizes the participant considers acceptable. That interest is coupled with a standardized presentation to the system of the degree of willingness to trade at each price and size point, across a spectrum ranging from a 1 completely willing to trade to a 0 unwilling to trade. References to OptiMark as three dimensional are based on this, with the three dimensions being price, size and satisfaction level.
OptiMark is an open rather than proprietary system, functioning as a facility of the existing infrastructure and requiring users to have their own clearing and settlement brokers. Thus, rather that fragmenting the market as closed systems inevitably do, the OptiMark system will help to integrate the market, increasing liquidity and lowering market-impact costs.
Lastly, because the system optimizes the matching of orders, filling those that represent the highest levels of negotiation value first, and because of its abilities to attract additional liquidity to the market and to aggregate small orders to provide a match with larger orders, the opportunities for price improvement are enhanced.
Q: Are OptiMark's features available from other electronic markets and crossing networks?
A: No. Instinet provides anonymity, but does not provide non-disclosure. The Instinet Crossing Network and POSIT are designed to provide anonymity and non-disclosure among users, but do not provide internal price discovery.
In addition, both of the aforementioned systems are operated by broker dealers, which means that their use by institutions supplants other brokerage relationships. OptiMark is not a broker dealer. The Arizona Stock Exchange (AZX) system offers a periodic, anonymous, single-price call market, but with far less frequent calls (now three times a day rather than every 90 seconds with OptiMark). The AZX accepts only standard limit orders, as opposed to the expression of total trading interest available via OptiMark satisfaction profiles. In addition, the AZX is a proprietary system. OptiMark is an open system and integrated with the NMS.
On OptiMark, a participant's strategy is never disclosed to anyone, including OptiMark personnel; as represented on an OptiMark profile, a strategy remains private, known only to the fully-secure, Deloitte & Touche-tested OptiMark system itself.
Even when a trade results from the matching of a participant's trading strategy with one or more participant strategies, only the results of the trade are made public. The identity of a participant is revealed only after a trade is executed, and only at the end of the day to the clearing broker. The only exception made to this rule is for surveillance purposes by exchange and regulatory personnel.
Q: Will OptiMark hurt broker dealers' business?
A: No. Broker dealers will use OptiMark for their proprietary trading and as agents for retail and institutional trades. Although some institutions may directly access OptiMark to preserve confidentiality, such institutions, of course, must still designate, and pay a commission to, one or more broker dealers to handle clearing and settlement of any trades that result. Thus, brokers will not be cut out of the process.
In fact, far from losing business, broker dealers should enjoy increased business if OptiMark results in significantly increased trading volumes, as we expect it will. Many brokers are developing value-added services for their customers around the OptiMark system. As with specialists, OptiMark provides broker dealers and market makers with the ability to reliquify proprietary positions with speed and anonymity.
Q: Are specialists vulnerable?
A: No. The specialist book for participating exchanges can be fully represented in the system, allowing specialists to utilize OptiMark's liquidity every 90 seconds to find liquidity for their limit orders, while, between OptiMark calls, they handle market-order and executable limit-order trades. OptiMark allows specialists to reliquify their positions with a speed and confidentiality otherwise unavailable.
Q: How does the Nasdaq and OptiMark plan affect dealer capital?
A: OptiMark provides market makers with a mechanism for price verification and proprietary-book reliquification in an anonymous environment. Many dealers have expressed the expectation that these facilities will lower their capital risk.
Q: Will OptiMark force brokers to reassess the value of their research services?
A: OptiMark does not change the relationship between broker dealers and their clients. This fact distinguishes OptiMark from other electronic trading systems.
It is true that institutions can trade directly with one another using OptiMark, but they must designate, of course, a broker to handle clearing, settlement and credit. These brokers receive their commissions for the trade just as they would for a non-OptiMark trade.
If a broker dealer provides valuable research to an institution, that institution can designate that broker to receive credit for its trades as compensation for providing the research. In fact, since an OptiMark trade is, by definition, best execution, we make it easier for smaller research brokers to get compensated by institutions that use their research.
Q: If the New York Stock Exchange does not sign up with OptiMark, investors could still send listed business directly to Nasdaq dealers or to OptiMark?
A: OptiMark is an open system, and none of our agreements are exclusive. Any exchange can enter into an agreement to make OptiMark available as a facility for its members' use.
Q: Finally, will OptiMark be used exclusively for U.S.-listed equities and Nasdaq stocks?
A: The PCX expects to launch the OptiMark system for trading listed equities in mid-1998. Subsequently, Nasdaq also plans to introduce OptiMark to its members. Trading in options and other instruments is scheduled to commences on the PCX and on the Chicago Board Options Exchange after the initial launch of the system.
OptiMark is also pursuing agreements and relationships with other domestic and international equity and futures markets.
