What is bid rate and ask rate

Futures prices and "bid / ask" spreads in stock market futures trading

 

As soon as and as often as a trader enters the free financial market, he inevitably encounters two very different types of price offers in the trade there: "ask price" and "bid price".

The price at which the visitors to a market certain quantities of the goods brought to market - be it forex, stocks, bonds or the financial market instruments derived from them - with immediate conclusionto buy can means "ask price"(in technical language often also as"offer price"; in German: Ask price, offer price);

the price at which the traders visiting the market set certain quantities of those commodities brought to market with immediate conclusion to sell can means "bid price" (German: Bid price, Demand bid, Demand price).

In banking and stock exchange, the addition "bid" expresses the fact that the price provider ("price maker", "market maker"), which marks its course with this identification, seeks the relevant market item at the stated price; conversely, the addition" ask "indicates externally that the course provider has the market item for sale at the advertised price.* In short: "bid" indicates the intention to buy, "ask" indicates the intention of the trader to sell at the price quoted.

[* Price brokers who continuously submit both buy and sell offers for the values ​​they care for on the market must be ready and able to take certain quantities of the market item in question at the formulated "bid price" and certain quantities of it for the announced price at the same time Submit "asked price". If you want to achieve profits and avoid losses, the "ask price" of the quotation quoted must be set a little higher than the "bid price". If ever, the "bid price" will rarely be placed above the "ask price". If so, one speaks of an inverted course position ("inverted"), with equality of"choice".]

For all course information that combine the "bid" and the "ask" course into one expression, i.e. that appear in pairs, the name has been useddouble-sided quotation ("two-way", "quotation", "quote"). Quotations are always named according to the above interpretation from the point of view of the person who puts them on the market. This group mainly includes financial institutions such as banks, brokers and brokers As is customary in the language, the (lower) "bid price" is listed first, then the (higher) "offer" price assigned to it. From a formal point of view, the "bid" price always precedes the "offer" price Quotation takes up ("price taker"), can choose whether he wants to sell at the present" bid "price or buy at the" offer "price ("two-way"). Whoever thinks of it, however, on the basis of a market rate quotation ("proper quotation") to buy at the same time and If he is serious about selling, he will have to suffer an immediate loss in the amount of the existing price difference between "bid" and "ask". - The price difference between "bid" and "ask" is generally called the bid-ask spread ("bid / ask spread", "bid / offer spread"; Margin).

An (outside) person approaching the futures exchange who has contracts for futures or options (futures, "traded options") is determined to act, before they place an order, they want to find out about the current market situation. Among other things, they will use the exchange price prevailing on the market (quotation of the futures or the option premium) as the basis for their The information claimed can be obtained from a wide variety of data sources. In the life of the stock exchange, such information can be obtained as quickly as possible, for example by making an inquiry to a "floor broker" or an approved market maker ("request for quote RFQ, "quote-request", "price request"), furthermore" indicative "via electronic price information systems, for example via a screen terminal of a stock exchange, or at any other location with the help of modern networked transport vehicles that deliver the required information specifically through a commercial market data provider ("quote vendor") or freely via the Internet" online "on a telephone or computer system at home.

For example, a market quote taken from the current status for the on the European futures exchange Eurex listed September21-DAX®-Futures are: 13830,0 "bid" 13830,5 "offer".* From the quotation asked above, the knowledgeable trader can see that the September21-DAX®-Futures can be bought from there with immediate consent in a long position (buy position) at 13830.5 index points. But he could just as well count on the execution of his order at 13830.0 index points right now, perhaps in order to build up a short position (sell position) in this futures contract or to cover an existing long position. If it crosses the mind to turn down this offer, be it because they are less inclined to bid than the "ask" price, or because they are asking more than the "bid" price, they are not given a chance at the moment . He must either wait patiently for a price level that is convenient for him to conclude the contract, or take into account the circumstances and finally withdraw from the market without having achieved anything ("passport").

[* Quotations appear to the outside, observing reflector as variables given by the market situation to which he has to adapt in his decisions ("price taker"). This does not prevent him from taking action on his own orders. Note: Information on the result of the quotations taken from the current situation ("tick-by-tick") is available to everyone at all times from various brokers, news agencies ("quote vendors", Data provider, data vendor), via special information services on the Internet, and as a complementary service, of course, from the futures exchanges themselves.]

 

A deeper insight into the order gradation prevailing on an exchange, consisting of the best quotations in each case, i.e. the currently highest "bid" and the currently lowest "ask" price of such, as well as from a certain spread of subordinate "bid" and "ask" prices of a market ("behind") in conjunction with the number of contracts that can be traded each time (price and quantity offers;"inside market") and, if applicable, the name of the currently active market maker, allows a view of the exchange's central order book: the so-called order book ("quotations-book"), which is sometimes also referred to as the incoming book or» order book «. In the central order book of an exchange, which for obvious reasons is always in purely electronic form as a file on computer exchanges ("file") is available, regular trading orders including quotes of any kind with their associated trading volumes flow in. Orders that have been presented are initially broken down according to the aspects of order type, price and time of delivery. Illimited orders are executed immediately a special execution restriction (e.g. every price-limited order received on the stock exchange), but cannot be directly merged at the first attempt due to the given supply and demand conditions, are sorted into the order book and remain there for the time being reserved for later processing (order book creation)*. If the trading volume and price of two previously unfinished orders coincide in the further course of the market, the corresponding orders are read from the order book and automatically merged by the technology of the exchange facility according to very specific prerogative features ("order precedence"; "matching"). The parties involved in the deal are then sent a note about the execution of their orders (closing note;"purchase and sale statement P&S").

[*Note: Orders are placed in the futures exchanges' order system to the extent that the identity of the original client is deliberately not disclosed to the respective contract partner or the outside world, so that no one except the exchange itself is displayed. The affiliated clearing house of the futures exchange automatically intervenes in every business transaction that has been concluded from outside, whereby this becomes the counterparty of each original party from the same moment on. Mutual anonymity therefore remains in place after an order has been merged and the clearing house has been involved.]

In general, a distinction is made between open and closed order books and their mixed forms according to their accessibility, whereby in the latter case - depending on the degree of intended market transparency - the entire depth of the order structure* is not apparent to everyone. At the futures exchange Eurex E.g. the market players are denied insight into the stop and market orders of third parties. In addition, as mentioned in the note, the personal identity of the individual market participants is strictly hidden from others, so that no one knows anything about the other. It also remains hidden whether a quote is based on a single or a multi-level order. Finally, it should be mentioned that futures transactions carried out over the counter (OTC) are not entered in the central order book.

[* The order book depth is a key parameter for assessing market liquidity (see below).]

 

Market maker, "bid / ask" spread and pricing process

In principle, the trading margins of fungible market instruments (stocks, futures contracts, "traded options", "Forex", CFDs, "certificates" and other restructured products, etc.) made public in the financial markets can appear in two different forms:

1.) as quotations, as they arise in constant succession from the trading flow of individual special market participants* - For example, binding quotes offered by a very specific market maker who carries out his activity under a price-controlled "monopolistic (pure) market maker system" by paying a purchase price himself for the values ​​he is responsible for during the holding times (Bid price, "bid") together with a sales price (Ask rate, "ask", "offered") to the general public (continuously or whenever you want on request, without necessarily disclosing the true commercial intent), or

2.) in the form of a price range, such as is directly accessible for observation to the public in an extensive, order-controlled market of an exchange. The best "bid" at the current moment together with the best "ask", i.e. at the same time the narrowest range, then reflects the current market situation in the relevant instrument in the overall balance sheet.

[* Note: In a traditional auction market ("continuous auction market") with call trade ("open outcry") on the floor of a futures exchange," bid / ask spreads "came primarily from so-called" pit traders "and from" scalpers "(=" voluntary market-making "by"locals"). Especially in hectic sections of the market it could be problematic to get an overview of the actual situation on the floor. It is different in the case of electronic trading facilities: Here the respective bid-ask spread can be read straight away from the trading screen.]

Accordingly, one speaks of a in the former caseBid-ask spread ("bid / ask spread", "dealer spread"), in the latter from theMarket margin ("market spread"), as it regularly arises with the participation of numerous market participants during a publicly held trading phase in an" order-driven continuous auction market "(order-driven continuous trading) and presents itself to outsiders for observation.

Regardless of whether it is market tension or bid-ask spread: given price quotations are derived in a straight line from the currently available on the market as well as from the highest-limited buy or lowest-limited sell offers that are registered at the same time*. Since each of those involved in the market is strictly concerned with his personal economic advantage, the "ask" price of quotations will in regular proportions be slightly higher than the "bid" price assigned to him. This fact of experience is independent of the form of market organization, and you will find it accordingly both in an order-driven auction market and in a market maker market. The range between "bid" and "ask" also limits the area of ​​agreement to the next stock market price that has yet to be determined. Every binding quotation kept ready ("firm quote") is basically just as likely to a validity period of a limited period (holding period) as to an acceptable transaction size ("size"). In addition, there are relevant guidelines on the stock exchanges with regard to existing minimum transaction sizes (minimum quote amount,"minimum quotation size", MQS), to which all participating market makers without exception must strictly adhere.

[* This implies that limit orders the market liquidity c. p. increase, while market orders increase this c. p. Reduce.]

In those futures and options markets that are organized according to the market maker procedure ("quote-driven-markets"), by naming binding quotes, market makers provide both their peers and the other participants with information about the" bid "or" ask "prices at which they are short-term contract quantities ("bid quantity", "ask quantity") are willing to act at least or at the highest level. In the opposite case of an order-driven auction market, the bid-ask spread can be understood as compensation for the willingness to trade at the limit prices of the orders in the market*.

[* An illimited order arriving at the same time ("market order") would ultimately be matched directly to the current limit price of orders with a limited price.]

The quoted "ask" price of a market maker reveals the limited price at which he is inclined to sell, while his "bid" price shows the limited price at which he is willing to buy. Normally he will try to get rid of what he buys at the lower "bid" price at the higher "ask" price in good time. From this point of view, the market maker primarily acts as a hedger or arbitrageur rather than a speculator. At the same time, through his permanent readiness to trade, he ensures a balance between supply and demand.The surplus of derivatives in between and at the end of a trading phase is regularly secured in value by means of compensatory measures.

In the breadth of the spread between "bid" and "ask", the main thing is twofold: first, the (uncovered) risk assumed by the market maker who set the price* from open items, which he has to keep available in varying amounts and with different durations in the course of his activity, and secondly, his own "operating costs" from ongoing transactions, which are "ready to trade at any time ("immediacy") to other market participants". Since market makers not only hope to cover their subsistence costs, but also hope to earn money on the range from "bid" to "ask" (profit margin, gross income margin), they will adapt their quotation behavior and their respective quotations depending on their business policy trading intent and assessment of the situation Align it in accordance with the market and the risk. For example, in the case of increased risk, i.e. in more volatile markets, they will have wider ranges than in the case of moderate risk and moderate volatility. If, however, the risk is felt to be too great, for example in view of constricted market traffic or impending market illiquidity, such a circumstance can lead to either individual market makers holding back for the time being, which means that they are temporarily absent from the market, or it even leads in extreme case of a state of incalculable risks lasting for a long time to the fact that the latter are fed up with the market and turn their backs on unsolicited things forever - insofar as they are not obliged to continue their trading activities by mandatory stock exchange rules.

[* This is especially so-called. unsystematic risks (i.e. property-specific risks, as opposed to market-specific risks), but also those risks that result from the obligation to trade with anyone who may be better informed ("adverse selection").]

Market makers do not have a completely free hand on all futures markets to set their quoted price spreads as wide as they want. Unusually wide price spreads can generally be interpreted as an indication of an unspoken demanded risk premium (risk premium), as it is e.g. in the event of a fast market ("fast market") is often to be observed and also necessary. At almost all futures exchanges, such as the Eurex, there are dedicated stock exchange regulations with regard to the greatest possible numerical difference in the "bid / ask" spreads. For each type of contract, the management of the stock exchanges particularly decide on the extremely permissible amount of the "bid / ask" spreads, which appropriately turn them into predictable, binding and strict instructions for the traders ("maximum quote spread") *. Market makers who violate the latter or other trading regulations would have to face disciplinary sanctions, such as warnings, in the event of repetition with a temporary block through the temporary suspension of the trading license ("suspension"), or, in the last instance, expect the license to be withdrawn and therefore permanent exclusion from the market ("exclusion").

[* When determining an appropriate amount for the largest possible price spread to be specified, proceed with a sense of proportion. It shouldn't be too big or too small. Excessive price targets would be detrimental to the flow of trade in view of the associated increased costs and risks; too low, on the other hand, caused the market makers' profit margins to shrink with the undesirable consequence of deliberately ceasing their trading activities.]

A formal conclusion (sales, "trade") is realized under the market models customary in stock market futures trading as soon as the requested forward price covers the approved one. A conclusion is expressed in the fact that the buyers and sellers appearing on the market come to an agreement on a specific contract price at that moment in terms of coverage The margin between "bid" and "offer", which has just been stipulated by mutual competition, naturally shrinks to zero for a logical second of the closing time ("matching"). One can also say that it narrows at the moment of the market act to an equilibrium point. The agreement on a price with the completion of a business transaction necessarily requires opposing market expectations. The demanded upper price limit of the buyer (long) is thus above the approved Price lower limit of the provider (short). Within the enforceable limits, the price will take its place where supply and demand are in quantitative equilibrium. The price of the last deal concluded is henceforth the benchmark for the actual market price ("current price", "last traded price"), until further orders can be executed against each other and are able to bring about a new conclusion in this contract market under the conditions set. Whether a subsequently determined exchange forward price is at a higher or lower point or remains unchanged depends again solely on strength , Depth and scope of supply and demand.

An expedient organizational form of exchange-based futures trading ("market model") defines both the type and mode of operation of the mechanism by which it regulates the way in which transactions are made on the exchange. A recognized usable market model of the derivatives exchange guarantees that a rule-based pricing process through the interaction of supply and demand can continue and take place unhindered on this site ("price discovery", Pricing function). In the event of disruptions, for example due to a reduced liquidity situation as a result of a weakly occupied market, suitable counter-efforts are made in such a way that market makers take action to improve the tense situation well-trained, lively trading ("price competition") means that every futures purchase is consistently concluded at the lowest of all specified "offer" rates, and every futures sale in the same way at the highest of all specified "bid" rates in the market True to this guiding principle, the best possible ("fair market") price for all parties directly involved in market transactions with financial derivatives can be achieved economically while maintaining equal opportunities for a business transaction ("market integrity", increase in liquidity and market transparency z). The latter from the "market-bid" and "market-ask" ("inside market") derived closing price ("excecution price") reflects the real business situation on the stock exchange in an exemplary manner.

Almost all of the stock exchange rules ("matching rules") relevant to trading provide for this purpose that among all the orders collected in the order book - regardless of the person of the client - the highest "bid" price takes precedence over all others " bid "prices, the lowest" offer "price the forehand has before all other" offer "prices (priority control). If the prices are at the same level, the time of the setting is usually ("time stamp") of the relevant orders in the trading device of the exchange decisive for the order in which they are processed (price-time priority as the criterion of execution priority), whereby the motto generally applies: First come, first served (" first-in / first-out "). The scope of the order could also be considered as a further priority claim.*

[* The futures exchangeEurex next to this knows the so-called "pro rata matching" procedure, which is used for some selected, less volatile instruments, such as B. Money Market Futures, finds excellent application. Regardless of the entry time, the best "bid" or "ask" prices in the order book are based on deals in a proportional relationship to the total order volume.]

Increased trading leads to narrowed bid-to-ask spreads under otherwise undisturbed conditions on the stock exchanges. The narrower the spread of bid to ask prices in the market, the smoother and more straightforward even larger orders at or close to the price of the last negotiated market price can be placed at the relevant place in steady succession. The extent to which a market is able to continuously meet this quality mark is usually reflected in the extent to which it isDepth of Market ("depthA "deep market" has the beneficial property of keeping the scope for price movement as narrow as possible while it is largely unaffected by increased order volume. This is its special property recognizably resistant to the development of a "slippage" effect, which is generally felt to be extremely unpopular*. In addition, a "deep market" is characterized by the fact that the individual quotation jumps from one price quotation to the next are relatively close to one another, with the result that the most recently negotiated price provides a credible indicator of the level at which the next one will settle . A "deep market" thus makes it possible to build up a position just as quickly as a quick and convenient detachment from an existing item if necessary, without noticeable disadvantages in prices, caused by self-made or third-party trading activities ("market impact"). A" deep market "promotes the flow (" continuity ") of the market development to the best of its ability. A look at the order book provides more precise information about the depth of the market.

[* Under a"slippage" effect one understands the circumstance of an unwelcome, undesirable, sometimes quite violent change in the price between the time of the submission of an order to be executed with the highest urgency (e.g. a market order) and its final execution in the market ("matching").]

The basic requirement for sufficient market depth is a market that is filled by a sufficiently large number of market participants on both sides, in which, according to the original idea, all of their different motives for action meet in free, extensive and fully effective competition (=Market breadth, "market width"). Only in the state of an extended market width with a corresponding depth can the current market price be placed on a proper, secure basis appropriate to the market value ("fair value"). According to this, the empirical principle comes into its own: the broader a market and the more pronounced the barter (turnover,"trades") is able to develop, and the lower the volatility and the expected risk in this market, the closer the bid-ask spread in which the market price will be determined will come together. Tight bid-ask spreads (understood as" market Spreads ") are the expression and direct outcome of a functioning, receptive and liquid market*. Liquid markets are desirable because only in a liquid market with correspondingly narrow bid-ask spreads can individual adjustment decisions be made to newly arriving market-relevant time events through appropriate business activity, i.e. through building, maintaining, rearranging, rotating, hedging or closing positions, silently and without Allow frictional losses to be implemented. The moment of liquidity makes a very good contribution to perfecting the market area.

[* From this it appears understandable and plausible that frequently occurring major fluctuations in the liquidity of a futures market can sometimes manifest themselves in the form of a liquidity premium on the futures prices. The degree of liquidity of a market can be measured on the basis of the required transaction size to which it noticeably responds.]

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"bid / ask" spreads and transaction costs