One of the most interesting developments in the SEC’s determinations of the probable causes of the stock market “Flash Crash” of 2010 was that stub quotes played a crucial role in the day’s tumultuous events. Not as a cause, but as an exacerbating factor. Now the exchanges are asking for SEC regulations that will effectively ban this procedure or, at the very least, curb it so that the effects won’t be as potentially damaging. So what are these stub quotes everyone seems to be in an uproar over?
A Stub Quote Dissected
Stub quotes are essentially placeholder quotes that market makers put into place that are far outside the boundaries of a stock’s market price. For example, a firm could set stub bids at 1 cent per share, and stub offers at an equally outlandish price—like $1000 per share. This isn’t done with the hopes of actually trading at such extremely high and low stock prices, but as a way of putting safeguards in place that will, under normal circumstances, prevent any trades from taking place in either direction. More often than not, these quotes are submitted just to satisfy SEC regulations that require bids and offers to be simultaneously laid out.
The Trouble with Stub Quotes
The problem is, stub quotes don’t mix well with an extremely volatile market, the likes of which was seen on May 6 as news of deep government spending cuts in Greece sparked riots in Athens and nervousness among international investors. As the market plummeted, stub quote thresholds were reached and retail and institutional stop orders were triggered and executed. The result was a domino effect that played out like a comedy of errors, without the laughs.
Whether or not the SEC will impose limitations on stub quotes awaits to be seen, but it is an interesting turn of events to see that not everyone is putting sole blame on high frequency traders as the one and only cause of the 2010 Flash Crash.
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