Fun because the whole question of whether high frequency trading is a liquidity taker or maker is still an open question in my book. I know the academic guys say HFT creates liquidity but in the back of my mind is the suspicion that said academicians probably don't want to screw up a sweet consulting gig somewhere down the road.
Nobody creates liquidity for free.
Here's an example that's prima facie counterintuitive but which when you think about it makes a lot of sense:
Levitt, Bogle debate penny ticks
Businesses eye wider bid, ask spreads to bring small stock liquidityNobody creates liquidity for free.
The nation’s securities watchdog is gearing up for a major debate next month about whether the penny spread between bids and offer prices on stocks helps investors or stifles initial public offerings and contributes to an epidemic of illiquidity for small publicly-traded companies.
And former Securities and Exchange Commission chairman Arthur Levitt along with Vanguard founder John Bogle have conflicting opinions on the matter.
At issue is a regulatory system that has evolved over the past decade and a half, with the shift from quoted to electronic markets in 1998 and culminating in a 2001 SEC rule known as “decimalization” where the spread size between bids and offers on stock exchanges was reduced from 25 cents to a 1 cent minimum “tick size.” A tick is the minimum pricing increment that can be used to trade securities.
Proponents argue that wider increments will help kick some life into illiquid, small public companies by giving small boutique investment banks the incentive to trade more in micro-cap and small public companies....MORE at MarketWatch
The roundtable is scheduled for February 5.
From Kid Dynamite:
Last week, Zerohedge noticed that the Ishares Silver Trust ($SLV) reported a sizable increase in its silver inventories on Wednesday night (January 16, 2013). You can see all of SLV’s historical data by going to their web page and clicking on the “historical data” spreadsheet. So let’s take a step back and remember how SLV (and other ETFs) work.
SLV does not go out and buy silver. They don’t have to go procure silver. Rather, their creation/redemption mechanism lets the market (Authorized Participants, of course) bring silver to them (and, vice versa: take silver from them). When you buy shares of $IBM, your money doesn’t go to the Company – it goes to the seller of the shares, and when you buy shares of SLV, your money doesn’t go to the Trust for them to buy silver with. If you read anyone suggesting otherwise, you should immediately put them on your “suspect” list, as they have no idea what they are talking about.
The next question noobs always ask is “How on Earth can they possibly move so much silver overnight?” Well, that’s why SLV has their vaults in London, alongside the center of the bullion-trading universe. When an Authorized Participant wants to create shares of SLV, the just transfer the title of the allocated bars. There are almost certainly no 18-wheelers and forklifts involved (although there may be some eventual intra-vault movement via forklifts). In other words, they just record the change: “BankXYZ used to own bar JM20131003, but now SLV Trust owns it.”
Final noob point: the availability of 1000 ounce London Good Delivery bars is totally separate from the availability of 1 ounce silver rounds used by the U.S. Mint. The next common question is usually “HOW CAN SLV FIND 18MILLION OUNCES OF SILVER WHEN THE US MINT CAN’T FIND ANY?!?!” Well, the U.S. Mint can have all the 1000 bars it wants. This is the difference between shortages of silver and delays in processing silver rounds. So can we move on to the interesting parts?
The question at hand, of course, is: “What does this large SLV inventory add mean? What does it imply? Is it bullish or bearish?”
In ETF-101-thought, we generally associate increasing inventory of ETFs as indicative of rising demand for the ETF or the underlying product. As I explained in ETF Lesson Part I, increased demand (buyers) results in the ETF trading “rich” to its fair value, at which point arbitrageurs step in to short the ETF and buy the underlying asset (silver, in this case). The arbitrageur then delivers the silver to the Trust (“creation”) and receives newly created shares which are backed by the metal that has been delivered. He uses the new shares to cover his short position and his arbitrage is complete: demand has resulted in increased ETF inventory, facilitated by the arbitrageur.
But if we look at the trading volumes of SLV last week, it seems pretty clear that this wasn’t a case of rabid investor buying of SLV shares resulting in this share creation arbitrage. In other words, it seems pretty unlikely to me that this creation was the result of normal market-making arbitrage reactions to mispricing.
So perhaps it was just a cleanup of a position that an Authorized Participant had sitting on his books for a while? In other words, perhaps the AP was sitting with a large short SLV position vs a long bullion position and decided to close it out (again, by delivering the bullion to the Trust and creating new shares to cover the short)? We can better evaluate this possible explanation when updated short interest data comes out, but I also find this explanation unlikely for the following reason: that’s something that the APs would tend to do in order to clean up their books and balance sheets for year end – not during the 3rd week of the year.
My next thought was that perhaps this was a case of someone wanting to take a large bullish position in silver. In other words, InvestorX calls up his Authorized Participant and says “I want to buy $ 600MM of silver for a trading position – I don’t need to bother with vaulting the bars and all that headache – just give me SLV shares. I’ll pay you a penny a share above your equivalent NAV cost basis.“ We’d call this a “basis trade”...MORE
