Price Improvement Processor for Financial Trading
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Solution Overview
Problem
In the electronic trading of financial instruments, particularly equity option contracts, there is a challenge in rapidly closing bid and offer spreads, leading to suboptimal pricing due to the prevailing minimum price variation and lack of competitive price improvement mechanisms.
Innovation Solution
A price improvement processor facilitates a rapid automated secondary auction within the primary auction, allowing market participants to provide finer price improvements with incentives, enabling direct interaction and competition among market makers and Order Flow Providers to improve customer orders beyond the National Best Bids and Offers, promoting tighter spreads and better pricing.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Measurement precision
If a rapid automated secondary auction is implemented for price improvement, then price improvement speed and precision are improved, but system complexity increases
Solution Approach 1:
The trading system is segmented into distinct functional modules: the primary auction engine handles standard NBBO trading, while the secondary price improvement auction is a separate, dedicated subsystem. This segmentation allows the complex price improvement functionality to be isolated and managed independently, reducing overall system complexity while maintaining high precision pricing capabilities.
Solution Approach 2:
An automated intermediary system is introduced to mediate between market participants and the order book during price improvement auctions. This intermediary automatically matches orders, manages pricing increments, and coordinates trading activities, eliminating the need for complex manual coordination and simplifying the overall system architecture while achieving rapid, precise price improvements.
2Ease of operation
If minimum price variation is increased to standard increments, then trading simplicity is improved, but price improvement capability deteriorates
Solution Approach 1:
The system dynamically adjusts price variation increments based on the trading context. During standard NBBO trading, conventional price increments are used for simplicity. However, when a price improvement auction is initiated, the system automatically switches to finer price increments to enable precise price improvements, thus adapting to different operational requirements without compromising either simplicity or precision.
Solution Approach 2:
The price increment parameter is changed based on the auction phase. In the primary auction, standard price variations apply. In the secondary price improvement auction, the system modifies the price increment parameter to allow smaller, more precise adjustments. This parameter change enables the system to maintain trading simplicity in normal operations while achieving superior price improvement capability when needed.
3Speed
If automated price improvement auctions are implemented, then trading speed is improved, but system reliability requirements increase
Solution Approach 1:
The system performs preliminary validation and preparation actions before initiating automated price improvement auctions. Orders are pre-screened for eligibility, participant qualifications are verified in advance, and system resources are pre-allocated. This preliminary action ensures that when the automated auction begins, the system is already in a reliable state, reducing the risk of failures during high-speed trading operations.
Solution Approach 2:
The system implements beforehand cushioning mechanisms by establishing backup matching algorithms, redundant communication channels, and error correction protocols before automated auctions begin. These preventive measures cushion against potential system failures, ensuring continuous reliable operation at high speeds without requiring excessive reliability margins during normal trading.
Data Source
AI summary
A price improvement processor to effectuate more rapid matching of bids and offers of financial instruments by conducting a rapid automated auction in which certain market participants may provide price improvement in increments that are finer than the prevailing standard minimum price variation and are provided a certain allocation as an incentive for such price improvements.