A few of us here at Fidessa Towers have been wondering about the spiky path fragmentation has taken over the past year or so. Whilst the overriding trend is upwards there have been a number of times when the rate of fragmentation has suddenly dipped only to recover its upward trajectory the next day. This was particularly evident with the FTSE 100 last month where the LSE’s average market share for February was around 40% and its average trade size was around 2,600 shares. Yet on Friday the 19th its market share suddenly jumped to 53% and its average trade size rose to 3,858. The Fragulator shows similar patterns in previous months when the LSE’s market share suddenly jumps on the third Friday of every month.
The clue as to why this happens could well be in the timing of the jumps, with the third Friday of every month coinciding with the expiry for equity options contracts. It’s likely that anyone in possession of an “in the money” option will seek to take – or force delivery of – the underlying asset (in this case, shares) on that day. This is then associated with a desire to crystallise the gain by liquidating the cash position and so the net result is a huge jump in equity volume traded on these days. The LSE actually facilitates this by having a special intra-day auction on these days and so, as a result, its market share gets a significant boost. Holders of such options seem uninterested in looking at alternative venues for better executions as they have already factored in their gains based upon the LSE’s price. I guess it’s a bit like finding out you’ve got a winning lottery ticket – you don’t really care what the cost of the cab ride is to go and collect your winnings.
If this analysis is correct then it’s another example of how the primary exchanges can use the concept of auctions to their advantage and effectively close out the alternative community. Obviously auctions are a useful and necessary part of an orderly market but the problem is how to make them work in a way that is fair to all venues concerned. BATS Europe, for example, has tried to introduce its own concept of an opening auction although this has met with limited success to date.
Anyway, this seems like another good “ask the audience” opportunity:
Finally, thanks to Electronic Broker for your comment on the last blog, Tick Tax. It raises some interesting points about the risk of overburdening the provision of market data and the source of competitive differentiation between the primary and alternative venues which I’ll be exploring in more detail shortly – stay tuned.