Negotiating The Bid - Ask Spread Using The Show Or File Rule

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 |  Includes: CTRX
by: Alan Ellman

When David did battle with Goliath, he used the leverage of his slingshot to overcome overwhelming odds. In much the same way we, as Blue Collar Investors, must use every tool available to us to level the playing field with the market makers and specialists who are taking the other side of our trades. One such resource is the Show or Fill Rule compliments of the SEC. The brokerages that serve as market makers are NOT going to highlight this regulation and encourage us to use it. That would be like Goliath handing David an article from Technology Today (I just made that up) describing the latest slingshot with a laser scope. So instead, we'll just have to discuss it in this article.

Show or Fill Rule - Definition:

Also called the Limit Order Display Rule or technically the Exchange Act Rule 11Ac1-4. This regulation requires the market makers to show or publish any order that improves the current bid or ask prices unless it is filled. Any order between the current bid-ask spread will improve the market.

Practical Application:

Most exchanges have a policy in place that requires market makers to fill at least 10 contracts at the quoted price. For many equities and ETFs the number of contracts required is a lot more and varies from security to security. These players want to buy securities at the lowest price (BID) and sell at the highest price (ask or offer). Now it's time for Blue Collar Investors all over the world to become annoying and take out our slingshots. As long as the bid-ask spread isn't too tight or close together, we place our order between the two quoted prices. If the market maker (MM) does not fill the order, he will be required to publish it and then be obligated to fill at least 10 contracts, perhaps more, at that price. Since most of us are selling small numbers of contracts, let's say up to 5 per stock, in most cases, it is in the best interest of our friends on the other side to just fill our orders and settle for a lower amount on 5 contracts rather than be obligated for twice that amount. We got them right between the eyes….I mean between the bid-ask spread.

Current example: Sxc Health Solutions Corp. (SXCI)

Click to enlarge

In this hypothetical the bid is $2.75 and the ask is $3.30. That's a spread we can work with. As covered call writers, we sell at the bid or in this case, $2.75 per share or $275 per contract. That's the price the MM wants to buy our options. Instead our offer will be $2.95. That betters the current published offer of $3.30. Therefore, our friend on the other side has a dilemma: Do I fill these 5 contracts at $2.95 or publish the new, improved offer and be responsible to fill 10 or more as required by the Show or Fill Rule? In most cases, we will get our $0.20 and the MM will get rid of us. This little maneuver will pay for our commissions and buy us lunch at Wendy's. $75 becomes hundreds, becomes thousands, becomes tens of thousands and so on. The MMs? They're gazillionaires anyway ... they'll be alright.

DO NOT CHECK THE ALL OR NONE (AON) BOX ON YOUR TRADE ORDER FORM:

For most of us this is redundant, not necessary because the MM is required to fill at least 10 contracts. If this box IS checked the MM is no longer required to publish our offer.

Conclusion:

Blue Collar Investors have certain tools available that will level the playing field with the MMs. Taking advantage of the Show or Fill Rule is an important one especially when selling a small number of contracts. Although each trade will generate small amounts of cash, over time this will add up to significant dollars that will help to secure our financial future. Unlike David, though, we are not looking to injure our adversaries, just annoy them.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.