Routing thoughts from Jeff Augen

[Guest listolyman]

I ran across this quote from Jeff Augen related to smart routing


I never use market orders. Also, I avoid "intelligence routing" because many brokers are paid for order flow. So i usually specify ISE or CBOE.

I think that Jeff executes a lot of intraday trades. Any thoughts? Has anybody tried this strategy to see if order fills are impacted or if commissions costs are impacted?



 

[RobertB 5]

Augen is correct in many cases. Smart routing, in my experience, tends to get you filled faster, but not necessarily at the best overall price especially when you consider possible exchange fees.

For this discussion remember that when you place a limit order to buy and your limit price is below the ask, this is considered a non-marketable order and thus ADDS to liquidity (possibly allowing you an exchange rebate). On the other hand, placing a limit order to buy at the ask (or higher) or placing a market order itself is considered a marketable order and thus SUBTRACTS from liquidity (incurring a possible exchange fee).

For example, suppose you wish to purchase an ABC 50 call. The current bid/ask is 1.00(bid)/1.02(ask) with ABC at 51. If you place a limit order to buy at 1.01 (the midpoint), that is NOT a marketable order and you are ADDING liquidity. Your limit order at 1.01 is declaring to the world that you are willing to buy at 1.01 or better. What you'd like is for that fact to be presented to other traders as the currently highest bid. Ideally, you'd like for some other trader to lower his 1.02 ask price down to 1.01 to meet your bid even if the market itself isn't moving in that direction. In contrast, if instead of using Smart you were to direct your 1.01 limit order to a particular exchange, that is what should happen: another trader would meet your bid, or the market may tick down to meet your bid. Either way, you'd be filled at your limit of 1.01 or better, and on many exchanges you would be thus entitled to a rebate since you had added to liquidity when you placed your limit order.

But with Smart and other intelligent routing systems, you are, in effect, saying that getting filled faster is the most important thing to you--not getting the lowest overall price. IB via Smart very often holds your order UNTIL it becomes marketable. That is, no one else even knows you have the best bid at that moment since IB holds your order in its servers until, in this example, the market itself comes to your bid on any one of a number of exchanges. At that point, IB submits your order and, significantly, an order that initially would have added liquidity (since your limit order to buy had been below the ask) is at submission time now marketable, and thus is subtracting from liquidity. You've just incurred an exchange fee of up to $0.45 a contract to which you would not have been subject had the Smart algorithm submitted your order when it was not marketable. Additionally, in return for these (possibly) faster Smart-induced fills, no one knew you initially had the best bid price (since IB held your order); thus, no trader was able to possibly meet it! (I suspect IB makes a lot of its profits through shifting these exchange fees in various manners to their own benefit. But that's another topic.)

There is an option under IB's Smart Routing configuration settings (in Global Management) that allows you to drop a hint to the Smart algorithm to attempt to give you the best rebate instead of the fastest fill. Also, you can update this setting on a per order basis in one of the drop downs in the Order Ticket dialog. To be sure, sometimes it will be to your benefit to get faster fills; other times it's best to get the lowest overall price (exchange fees considered). It's very important to always know how these things work so you can make informed decisions on how you'd like your orders filled.

Edited August 19, 2012 by RobertB

[Marco 221]

I'm not 100% sure but I think some of the above is inaccurate. I think with IB smart order routing the order rests in an order book of an exchange so will be visiable and should it be filled on that exchange will qualify for the rebate. You are correct though if they move the order to another exchange it might end up removing liquidity and you pay the extra fees. The smart order routing will take that into account though and only move it if you get a better fill INCLUDING that fee.

So in my opinion smart routing should give you the best fill. Not quite sure why Augen is so against it.

[RobertB 5]

Marco,

That hasn't been my experience. I have found IB holding my non-marketable limit order within IB's own servers, not sending to any exchange until marketable or nearly marketable. One of the reasons IB will hold an order is to reduce possible cancel/modify fees (for themselves). Their Smart algorithm tries to make educated guesses on which exchanges to send, with varying degrees of success.

I have found, as I've said, that Smart routing gives me the quickest fills, but not necessarily the best when all fees are considered.

And, in response to something you said, the Smart order routing will consider it a very low priority saving you exchanges fees. However, as I mentioned earlier, you can configure Smart routing to give priority to your getting rebates (in exchange for fewer and slower fills).

Anyway, this has been my experience. And speaking to IB about it from time to time has confirmed it. However, I'm still a big user of IB's Smart algorithm because most of the time, for me, getting filled at my limit, possible exchange fees and all, is better than my not getting filled more often.

Edited August 20, 2012 by RobertB

[Guest listolyman]

I seem to recall seeing some of my orders are assigned to a specific exchange(for hours or days) after selecting smart routing. i would think that it would only be assigned to an exchange for a short window if smart routing works the way that i assume. I'll try to pay more attention since my memory may be fuzzy.

[RobertB 5]

Listolyman,

I've seen what you mentioned also. But my main point is that with Smart routing in its default configuration you are leaving it up to the algorithm to decide which exchange is most likely to get you a fill. This is a separate question from which exchange (or combination of exchanges) will get you the best overall price. Like everything, it's a tradeoff.

[Marco 221]

well the order shows up in the order book instantly (and I can see other peoples orders there as well) and it must be visable to the market as well - otherwise how do you get a fill if you place a buy order which is below the offer? Maybe the smart routing only places the order in the order book once its better than the current bid (if you are buying) but it must rest the order in an ordre book at some point before it becomes marketable (otherwise you'd NEVER get a liquidity rebate either)

Have you changed your smart order routing setting to prioritise low exchange fees? Did you see any change in fills (speed) and/or exchange fees after that?

[Guest listolyman]

Marco, i was wondering the same thing. Jeff mentions that exchanges provide incentives to brokers to influence their smart routing. I was curious if anybody has experimented if there is a notable difference in fills and commission prices if either of the following are selected

1- trying best rebate instead of smart

or

2- selecting specific exchanges(e.g. ISE or CBOE)

I am considering my own experiment for a week or two. Average commission charges probably be objective but fills will probably be more subjective.

[Marco 221]

Marco, i was wondering the same thing. Jeff mentions that exchanges provide incentives to brokers to influence their smart routing. I was curious if anybody has experimented if there is a notable difference in fills and commission prices if either of the following are selected

1- trying best rebate instead of smart

or

2- selecting specific exchanges(e.g. ISE or CBOE)

I am considering my own experiment for a week or two. Average commission charges probably be objective but fills will probably be more subjective.

also I wonder why ISE/CBOE? Most liquid? No extra fees? (doubt if Augen cares about that)

[Guest listolyman]

Maybe Mark Wolfinger, Option Pundit, Kim, Chris, or any of the other Hero members have thoughts on this discussion. I'm not attached to any particular exchange. I assume that all traders(including Jeff) are interested in fills and commissions.

[RobertB 5]

Marco,

You're right. If that were always the case you would never get a liquidity rebate. But depending on your IB configuration settings for routing, if you don't have it set to bias for a rebate, you may find the Smart algorithm has decided to move your order to another exchange. Just last week I had that happen to me with Dell. My order when submitted was not marketable. By the time it was filled, however, it had been moved to the PCX exchange where I ended up paying $0.45 per contract "remove liquidity" fees. Had I set the configuration setting to bias for a rebate, this is not supposed to happen. Again, sometimes you'll want the order moved to a new exchange since you'd expect a quicker fill (but thus possibly pay liquidity fees); other times, no.

[Kelly Park 10]

I switched my preference in IB from SMART to Highest Rebate about a month ago and have not noticed much difference. My average commissions are down, due to less overall exchange fees. I haven't noticed any particular change in speed or ability to get fills. I don't have enough trade volume to make this definitive, but my average per contract has come down from .84 to .77, including exchange fees.

What I do notice is that my highest fees are always trades on PSE. If there were an option to exclude one exchange, I would try excluding PSE to see if it reduces my ability to get fills.

[Marco 221]

Marco,

You're right. If that were always the case you would never get a liquidity rebate. But depending on your IB configuration settings for routing, if you don't have it set to bias for a rebate, you may find the Smart algorithm has decided to move your order to another exchange. Just last week I had that happen to me with Dell. My order when submitted was not marketable. By the time it was filled, however, it had been moved to the PCX exchange where I ended up paying $0.45 per contract "remove liquidity" fees. Had I set the configuration setting to bias for a rebate, this is not supposed to happen. Again, sometimes you'll want the order moved to a new exchange since you'd expect a quicker fill (but thus possibly pay liquidity fees); other times, no.

my question (and i actually asked that IB today (lets see what they say)) is:

with routing configuration set to 'SMART' what exchange will the order be routed to if they have the choice between more than one exchange for the best price (that is marketable). I'd expect it to go to the exchange with the highest rebate/lowest liquidity fee. And with that configuartion set the 'highest rebate' wouldn't it still fill me at the best available bid or offer across all available exchanges? So I cant see the difference in both settings or the point of it unless 'SMART' picks an exchange at random (or possibly with the highest benefit to IB should they 'sell flow')

However I'd be surprised that an US broker could sell his flow and as a result I'd pay a higher fee AND they wouldn't even have to mention that.

[RobertB 5]

Marco, I'll be interested in hearing what IB has to say.

However I'd be surprised that an US broker could sell his flow and as a result I'd pay a higher fee AND they wouldn't even have to mention that.

Tell me what you think. But I interpret the following from IB's site as possibly allowing IB to do just that.

Costs passed on to customers may be greater than the costs paid by IB to the relevant exchange, regulator or other third party. For example, IB may receive volume discounts that are not passed on to customers.

Also, note the wording of the following, also from IB's site:

In those cases where IB routes to an exchange that is not currently posting the NBBO in order to reduce or avoid exchange fees, IB will guarantee the customer a fill at the NBBO at the time that IB routed the order.

Notice the phrase, "... at the time that IB routed the order." Well, IB has total control over when they route the order. This is not necessarily the same time that you submitted the order.

[Marco 221]

Marco, I'll be interested in hearing what IB has to say.

Tell me what you think. But I interpret the following from IB's site as possibly allowing IB to do just that.

Also, note the wording of the following, also from IB's site:

Notice the phrase, "... at the time that IB routed the order." Well, IB has total control over when they route the order. This is not necessarily the same time that you submitted the order.

yep sounds like they are selling their flow. Which i don't mind as much as Mr. Augen seems to as long as I get the NBBO and the best liquidity fee/rebate. So I think the MM that they sell their flow to would have to match the NBBO and if he only MATCHES it it would have to be on an exchange that has the same or lower liquidity fees as the one that he is matching. But from their answer i think thats what they give you. Here's what I got:

Any time you send an order that is marketable, the order is routed to the exchange that it will execute on. If there are multiple exchanges that the order can be executed on, it would first be routed to the exchange with the lowest fee, after the liquidity was removed on that exchange, assuming it was still executable on another, more expensive exchange, it would route there.

Changing the configuration of the smart router will change how non marketable orders are routed. If you pick highest rebate then the order will be sent to the exchange that offers the highest credit for adding liquidity, with smart picked, then the order is routed to the default exchange for the contract.

In either case, if you had a resting order at an exchange that became executable on a different exchange, it would be moved to the other exchange where it may be considered to remove liquidity and as such be charged for it.

So for me ticking 'highest rebate' doesnt change too much - you increase your odds of actually getting a rebate should the order be filled on that exchange that they initially rested your order in. But if it isn't they'll move ot to the exchange with the best price including possible fees and in the event they have more than 1 exchange to pick from they chose the one with the lowest fees. So I would not expect to see a dramatic change in either executions nor comissions. i think I'll tick that box anyway as it seems to increase the odds of getting a rebate (unless actually the exchange with the highest rebate totally sucks in terms of bid/offer spread and your order gets moved ALL the time to fill it as an other exchange will have a better b/o and you end up always paying the fee rather than getting the rebate on the exchange with the only 2nd largest rebate....)

[Marco 221]

alright, asked them again for some elaboration, thats a better explanation now. So 'highest rebate' might actually affect your fills. Guess I stick with the default smart routing then.

Here is an example, exchange A(the default) has no fee or credits for customer orders, exchange B charges 0.40 for removing, and credits 0.35 for adding, and exchange C charges 0.25 for removing, and offers no credit for adding.

For the option you want to buy the markets and sizes are as such.

A: 0.10-0.20 500x500

B: 0.10-0.20 1X5

C: 0.05-0.15 2x2

Your order is to buy 5 @ 0.10.

With smart picked, your order routed to A, the volume on this exchange is high, someone hits the bid and you are filled.

With highest rebate picked, your order routes to B. The option trades heavily on exchange A, but never trades at 0.10 on exchange B, your order expires at the end of the day unfilled.

With either strategy picked, the market on exchange C ticks down, it is now 0.05-0.10 2x5, your order is moved, executed, and you are charged for removing.

The second example is where you can run into issues with the highest rebate. We are not going to move the order to join a big on another exchange that is more liquid then the exchange the order is resting on. The order will only be moved if it crosses the market on another exchange.

The other option you have is to make the order post only. With this attribute picked, the order is never moved for execution. In the examples above, when your bid crossed exchange C, your bid would be reduced to 0.05 instead of being moved for execution, once your order would no longer cross a market, the 0.10 bid would be reinstated. With post only you may never get a fill, as your bid could be pushed down repeatedly. Additionally, should the market makers choose to not honor the away market, it is possible the exchange cancels the order entirely.

[ChadK 25]

Joining the party late, but thought I'd throw in my thoughts/observations, especially with respect to TOS. TOS is paid for order flow, mostly PHLX. TOS has claimed that they cycle through exchanges, but maybe it's 8 to PHLX, 1 to ISE, 1 to CBOE, then the next 8 to PHLX. I don't know, but it would allow them to make such statements and still be true.

TOS doesn't have a "SMART" feature per-se, but by defaults routes orders to the "BEST" exchange. Of course, is that best for TOS's order flow kickbacks, or best for getting my order filled at the best price...I don't know.

Here's what I do. I'll try BEST briefly. If that doesn't get filled in a timely fashion, I'll cancel/replace and route to ISE. Many times an order that's been siting for minutes, gets filled instantly when switching the exchange. Sometimes it doesn't, so I'll cancel/replace and route to CBOE. And now sometimes I'll cxl/repl and send to PHLX, as they are getting a LOT more volume these days on RUT. And sometimes, I'll even split my order simultaneously to 2 or 3 exchanges. That is, if I want to trade a 10-lot, I'll send 4 to ISE, 3 to CBOE and 3 to PHLX. Whichever gets filled first, and the others are still unfilled, I'll move them over to the exchange that I did get filled on.

Also, certain exchanges seem to have more volume than others, depending on the underlying. Attached are examples of AAPL (high CBOE slice of the pie) vs. RUT (high PHLX) for today's trading so far.

AAPL:

RUT:

[srf335 14]

ChadK, are you able to route complex orders (i.e. RIC's, butterflies, straddles, etc...)? I'm also with TOS and can only route a simple call or put order. For anything else, BEST is the only option. Thanks.

[ChadK 25]

Yes you can. Single leg orders can be routed to one of 8 exchanges. 2-4 leg complex orders can be routed only to BEST, CBOE, ISE or PHLX. 3 exchanges are better than none.

[srf335 14]

Thanks ChadK. Are you TOS or TDAmeritrade with TOS app? I'm just trying to determine how to get access to this option.

[ChadK 25]

I'm an original TOS customer. It would be strange that if you were a TDA customer using the TOS app, that there'd be less functionality.

[srf335 14]

I'd think so too, but it appears to be the case. I'll talk to them tomorrow to clarify.

[Kim 7,505]

I switched my preference in IB from SMART to Highest Rebate about a month ago and have not noticed much difference. My average commissions are down, due to less overall exchange fees. I haven't noticed any particular change in speed or ability to get fills. I don't have enough trade volume to make this definitive, but my average per contract has come down from .84 to .77, including exchange fees.

What I do notice is that my highest fees are always trades on PSE. If there were an option to exclude one exchange, I would try excluding PSE to see if it reduces my ability to get fills.

I opened a ticket with IB, they said there is no way to exclude a specific exchange. Still doesn't explain why on PSE, there is ALWAYS this fee. I even had an order yesterday (ORCL) which has been executed on 3 different exchanges. On ISE, I was charged 1.06 per contract. On CBOE2 I was charged 0.31 per contract. On PSE I was charged 1.21 per contract.

I assume that I got the "add liquidity" rebate on CBOE2 and was charged the "remove liquidity" fee on PSE and CBOE2. In general, I noticed that virtually every time my order is executed on PSE I got charged the remove liquidity fee.

[Xfanman 9]

I opened a ticket with IB, they said there is no way to exclude a specific exchange. Still doesn't explain why on PSE, there is ALWAYS this fee. I even had an order yesterday (ORCL) which has been executed on 3 different exchanges. On ISE, I was charged 1.06 per contract. On CBOE2 I was charged 0.31 per contract. On PSE I was charged 1.21 per contract.

I assume that I got the "add liquidity" rebate on CBOE2 and was charged the "remove liquidity" fee on PSE and CBOE2. In general, I noticed that virtually every time my order is executed on PSE I got charged the remove liquidity fee.

I just checked my last couple of days of trades and I was filled on PSE on part of FDX and all of GLD for .46 per contract on GLD and .38 on FDX. I'd noticed them being higher overall too I'd thought but recently - go figure! I don't track the exchanges on my trade journal so I'll have to pull up a trade report on IB to look further back.