3.3 Quoting
Securities Quoting
Understanding how securities are quoted and priced is fundamental to trading. This section covers bid-ask spreads, market maker roles, and the differences between auction and dealer markets.
Bid and Ask Prices
Every quoted security has two prices:
The Bid Price
The price at which a market maker will buy from you
The price you receive when selling
Always the lower of the two prices
The Ask (Offer) Price
The price at which a market maker will sell to you
The price you pay when buying
Always the higher of the two prices
Memory Tip: "Bid means buy" - the market maker is bidding to buy from customers at this price.
Quote Example
Bid: $49.95
Ask: $50.05
Spread: $0.10
If you want to:
Buy: You pay the ask ($50.05)
Sell: You receive the bid ($49.95)
The Bid-Ask Spread
The spread is the difference between the ask and bid prices.
Spread = Ask - Bid
Bid $49.95, Ask $50.05, Spread $0.10
Bid $25.00, Ask $25.50, Spread $0.50
Bid $100.00, Ask $100.02, Spread $0.02
What Affects Spread Width?
Liquidity: Narrow spread with high volume trading; wide spread with low volume trading
Volatility: Narrow spread with stable prices; wide spread with volatile prices
Competition: Narrow spread with many market makers; wide spread with few market makers
Stock Price: Often narrower in percentage terms; can be wider
Key Point: A tight (narrow) spread indicates high liquidity and an efficient market. A wide spread indicates lower liquidity and higher trading costs.
Market Makers
Market makers are dealers who stand ready to buy and sell securities, providing liquidity to the market.
Market Maker Obligations
Display bid and ask quotes during market hours
Trade at their quoted prices
Maintain orderly markets
Provide two-sided quotes (both bid and ask)
How Market Makers Profit
Market makers earn money through the spread:
1. Buy from customer at bid ($49.95)
2. Sell to another customer at ask ($50.05)
3. Profit = $0.10 per share
Note: With high volume, even small spreads generate substantial profits.
Auction Market vs. Dealer Market
Securities trade in two main types of markets:
Auction Market (NYSE)
Structure: Centralized exchange with single location
Price Discovery: Buyers and sellers compete openly
Key Player: Designated Market Maker (DMM)
Matching: Orders matched directly when possible
Quote Source: Consolidated from all orders
The NYSE is an auction market where:
Buyers compete to buy at the lowest price
Sellers compete to sell at the highest price
The DMM facilitates trading and maintains order
Dealer Market (Nasdaq)
Structure: Decentralized, electronic network
Price Discovery: Multiple dealers compete for business
Key Player: Multiple competing market makers
Matching: Trades through dealers
Quote Source: Each market maker posts quotes
Nasdaq is a dealer (negotiated) market where:
Multiple market makers compete
Each posts their own bid-ask quotes
Best prices displayed through the system
Comparison
Auction (NYSE): Location is a physical exchange; market makers are one DMM per stock; competition is buyers vs. sellers; example is New York Stock Exchange
Dealer (Nasdaq): Location is an electronic network; market makers are multiple per stock; competition is dealers vs. dealers; example is Nasdaq Stock Market
Inside Market (NBBO)
The National Best Bid and Offer (NBBO) represents the best available prices across all market centers.
Inside Market Defined
Inside Bid: Highest bid price available
Inside Ask: Lowest ask price available
Inside Spread: Difference between inside bid and ask
Example: Multiple Market Makers
MM1: Bid $50.00, Ask $50.08
MM2: Bid $50.02, Ask $50.06
MM3: Bid $49.98, Ask $50.10
NBBO:
Inside Bid: $50.02 (highest)
Inside Ask: $50.06 (lowest)
Inside Spread: $0.04
Best Execution: Brokers must seek the best available prices for customer orders, generally at or better than the NBBO.
Quote Size
Quotes also include the number of shares available at each price:
Reading a Quote with Size
Quote: 50.02 x 50.06 (5 x 3)
50.02: Bid price
50.06: Ask price
5: 500 shares available at bid
3: 300 shares available at ask
Note: Size is typically shown in round lots (multiply by 100).
Firm vs. Subject Quotes
Firm Quote: Market maker must honor the price and size
Subject Quote: Indicates interest but not binding
Nominal Quote: For information only, not tradeable
Regulation: Market makers must generally honor their firm quotes. Backing away from a firm quote is a violation.
Key Takeaways
Bid = dealer buys / you sell (lower price)
Ask = dealer sells / you buy (higher price)
Spread = dealer's profit margin
Narrow spreads indicate liquid, efficient markets
NYSE is an auction market; Nasdaq is a dealer market
NBBO shows the best available prices
Market makers must honor firm quotes