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Dark Trading at the Midpoint: Does SEC Enforcement Policy Encourage Direct Feed Arbitrage?

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  • Bartlett III, Robert P.
  • McCrary, Justin

Abstract

Prevailing research in market microstructure posits that liquidity providers bypass queue lines on exchanges by offering liquidity in dark venues with de minimis sub-penny price improvement, thus exploiting an exception to the penny quote rule. We show that (a) the SEC enforces the quote rule to prevent sub-penny queuejumping in dark pools unless trades are “pegged†to the NBBO midpoint and (b) the documented increase in dark trading due to investor queue-jumping stems from increased midpoint trading. Although encouraging pegged midpoint orders can subject traders to direct feed arbitrage, we estimate that less than 2% of shares traded per year present exploitable trading opportunities for this form of latency arbitrage, yielding annual gross potential profits of less than $20 million.

Suggested Citation

  • Bartlett III, Robert P. & McCrary, Justin, 2019. "Dark Trading at the Midpoint: Does SEC Enforcement Policy Encourage Direct Feed Arbitrage?," Journal of Law, Finance, and Accounting, now publishers, vol. 4(2), pages 291-342, December.
    • Handle: RePEc:now:jnllfa:108.00000039
    DOI: 10.1561/108.00000039
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    More about this item

    Keywords

    Latency arbitrage; high-frequency trading; dark pools; tick sizes; market structure;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law

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