Passive Rebate Arbitrage, Locked Markets, and Reg NMS Order Handling
Summary
The document describes a proposed passive rebate trade in which a trader posts a bid on one marketplace, waits for a fill, then posts an offer at the same price elsewhere. If another participant responds to the displayed price, the trader might complete both sides at one price and collect liquidity rebates. This depends on receiving fills in the intended sequence and on the relevant market rules permitting the displayed orders.
The answer says this setup cannot operate as described under US Regulation NMS, and notes that the example concerns the Canadian TSX. It also cautions that the proposal assumes passive orders will fill readily, a premise the respondent doubts. In the US, an order that would lock the market is generally routed for an immediate fill at the best price, with the resulting information disseminated as a trade. Venue-only liquidity instructions may instead cause the order to be hidden or price-slid. The short exchange does not establish profitability or detail jurisdiction-specific rules beyond this explanation.
Key ideas
- The proposed trade posts a passive bid, then an offer at the same price on another marketplace.
- The strategy aims to earn rebates by completing both sides at one price.
- Its success depends on passive orders receiving the needed fills.
- The answer says the described approach cannot be used under US Regulation NMS.
- Venue-only liquidity instructions may result in an order being hidden or price-slid.
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Full text
# Understanding Passive Rebate Arbitrage # Understanding Passive Rebate Arbitrage I was reading a BMO paper which offered the following example of passive rebate arbitrage: "For example, if BBD.b is trading at `$4.71` - `$4.72` with multiple players on each side, one might place a 'passive' order on TSX to buy 5000 shares at `$4.71` Upon receiving a fill, then proceed to place a 'passive' offering on another marketplace that does not have a bid at `$4.71`, thus locking the market: > `Bid Offer TSX 5,000 $4.71 $4.71 5,000 Pure TSX 10,000 $4.70 $4.72 15,0000 TSX ` ``` Bid Offer TSX 5,000 $4.71 $4.71 5,000 Pure TSX 10,000 $4.70 $4.72 15,0000 TSX ``` Counting on one of the bidders on the TSX to move their order to Pure and buying their stock. This achieves buying and selling at 4.71 and collecting passive rebates. If I understand correctly this would only work without Reg NMS? So you place a passive bid in TSX, lets say. And then as you get filled, you place a corresponding best offer at the same price level in a different exchange. This locks the market and without Reg NMS in place you could be getting filled in both places? Is this one of the reasons why Reg NMS bans locked markets? And also, if a market is locked with Reg NMS - is the only way of it unlocking by a match happening in the same venue or by a price slide? ## Answer by chrisaycock (score 5, accepted) https://quant.stackexchange.com/a/4711 You are correct that this cannot happen under America's RegNMS. Of course, TSX is in Canada. This "strategy" also makes generous assumptions about the likelihood of getting filled on passive orders. I doubt the author of this paper ever had much success with this. If a passive order were to lock the market in RegNMS, then that order is usually routed to the exchange with the best price for an immediate fill. This information is then disseminated as a trade. However, if the order contains special instructions to only provide liquidity at that particular venue, then the order is either hidden or slid.
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