One of the key tenets of Reg NMS (which has always been the cherry on top of a long process that began with a bunch of Wall Street banks and quants bribing regulators and politicians to first roofie stocks, and subsequently culminating with the gang rape by pimply 18 year old math Ph.D.'s of the entire stock market) is the "sanctity" of the NBBO: whatever happens, whatever insanity prevails in the market, buyers would always be prohibited from crossing the best offer, and sellers - the best bid (incidentally, there are exclusions to the rule but they occur only in options paired strategies). Which is why we read with great (lack of) surprise the latest piece by Nanex (recently famous for their dramatic quote-stuffing "crop circles" which day after day exposes the thieving douchebaggery of the HFT community for all to see, not to mention the criminal complicity of the SEC), that puts the very validity and credibility of the most fundamental concept of the stock market into question. In brief - Nanex concludes, and we certainly agree with them based on the presented evidence, that " the NBBO system cannot be relied upon and is meaningless."
What has set off Nanex so much? An ultra-detailed analysis of the May 6 crash has revealed that in the seconds and minutes immediately following the initial slam in the market, the dissemination of the NBBO by the Consolidated Quote System (CQS) would at times lag real time changes in stock crosses (as disseminated by such premium products as NYSE's OpenBook) by as much as 24 seconds! For those of you who don't need to look up latency arbitrage this should immediately make it clear why unless you are on the thieving team, you should immediately shut down shop and get the hell out of dodge. As the chart below demonstrates, the pinnacle of US stocks (at least until bankrupt crap like FNM, FRE, C and CIT took over), GE saw its CQS timestamps lag OpenBook by almost half a minute. In simple terms this means that a few hundred people knew well in advance that the stock was really trading at $15 even as Bloomberg and other commodity price dissemination services that subscribe to the realtime CQS were still showing $16, or maybe more. This is a criminal abuse of the most basic tenet of the stock market, and indicates that in times of stress only those who pay millions for their trading infrastructure (collocation services, frontrunning everyone else via DirectEdge, OpenBook accounts, etc) have a realistic view of what is really happening with the market! Note the latency at 14:45:55 below:
The ramifications of this phenomenon for real time pricing, and therefore, for market intergrity as a whole are humongous. In essence:
THE NBBO, IN ITS CURRENT MANIFESTATION, IS IF NOT BROKEN, THEN UNSTABLE AND COMPLETELY UNRELIABLE!
In case of doubts, Nanex has been kind enough to present several other charts the highlights precisely this phenomenon. We present these, together with Nanex' observations side by side:
The following charts demonstrate how an exchange's quotes can be chosen as the NBBO for that stock even when the quotes are woefully stale.
Chart 1 - 05/06/2010, Symbol LOW. The NYSE feed begins to delay at approx 14:42:40. We take a close look at the exchange crosses at 14:43. From peak to peak it is easy to determine the NYSE quotes are slightly behind although the time stamps are current.
In the detailed charts below, when an exchange has the BBO quote it is tagged with a circle on the exchange's price and size line in the exchange's designated color.
Chart 2 - 05/06/2010, Symbol LOW. In this chart you can see a detailed slice of time (from 14:43:00 through 14:43:24 and highlighted in the above chart) when quotes were initially crossing, CQS would choose NYSE, NSDQ, BATS or PACF (not shown for clarity) quotes as the BBO.
Chart 3 - 05/06/2010, Symbol LOW. In this chart you can see the full picture again from 14:41 through 14:46. Notice that when the price began to plunge the NYSE quote was consistently picked as the best bid despite the fact that during the plunge NYSE quotes were significantly behind.
Nanex' conclusions are all spot on:
Conclusion: Put simply, if CQS (Consolidated Quotation System) does not determine that quotes from a given exchange are stale, the possibility of it choosing those quotes as the BBO is inevitable. It is obvious from these charts (and from those presented in out original Flash Crash Analysis) that the NYSE quotes are stale. Furthermore, since the quotes are time stamped when exiting CQS, other market participants could not detect the NYSE quotes (and therefor the current BBO) were stale.
As small lags in time from quotes sent through CQS happen every day, the NBBO system cannot be relied upon and is meaningless until the time stamping mechanism has been fixed. This situation also makes the potential for latency arbitrage even more suspect as participants receiving premium NYSE products (as opposed to CQS) can detect these delays where-as others cannot. In the age of HFT's, where quotes can be sent at rates exceeding 5,000 quotes per second for one issue and can effect the BBO, delays of even 200 milliseconds (or less) become a lifetime.
CQS (Consolidated Quotation System) is the method in which 99.9% of all US market participants receive their data and is also responsible for calculating the NBBO for all listed stocks. There are however premium products direct from the exchange which are not disseminated through CQS. One such product is OpenBook from NYSE. In comparing time stamps of quotes from CQS to OpenBook, it is clear this time delay exceeded 20 seconds in many cases.
While Zero Hedge has been discussing the various nuances of just how fragmented and outright broken the market has become over the past 2 years, we have never encountered an example which puts the very foundations of Reg NMS at question. For without an unquestionable faith in the NBBO, who knows just what manipulation and outright fraud may be occurring behind the scenes: in those times when the CQS is delayed, those on NYSE's OpenBook, for example, can sells dollars away from the delayed best bid (and buy away from the best offer, although during a market crash there is little worry of this happening). It also begs the question: how often does this form of latency arbitrage occur, handing our free money to all those who enjoy the benefits on secondary, Non-CQS disseminated quotation systems. Of course, OpenBook would pay off for itself in a nanosecond if the new client knew that the regulators not only endorsed but facilitated this kind of daylight robbery of the "dumb" tier of market participants.
This is the kind of stuff that makes one's blood boil.
Luckily, there is at least one person who still believes in market integrity. Below we present Senator Ted Kaufman's latest letter to the SEC in which the Delaware senator writes "once again out of concern for the credibility of our equity markets." The 11 pages that follow are precisely the reforms that need to be initiated for the vast majority of the investing public to regain some faith in what has become a criminal free-for-all, far worse than any casino that may have graced the LV strip any time over the past century.