What Is Sub-Penny Trading?
Brokers and dealers that engage in sub-penny trading do so through wholesalers, dark pools, and light exchanges in unobserved, unregulated marketplaces in increments of less than a cent.
Exchanges controlled by the SEC are now prohibited from quoting deals in increments less than a cent under the Sub-Penny Rule (SEC Rule 612) of 2005. The National Best Bid and Offer (NBBO), the price benchmark utilized by off-exchange market-makers, may become unnaturally broad as a result of this restriction.
Understanding Sub-Penny Trading
In return for providing liquidity, exchanges and electronic communication networks (ECNs) charge access fees to each market player who accepts an offer or makes a bid that is posted.
The Securities and Consideration Commission caps the rebate given to participants who show the bid or offer at 0.3 cents per share in exchange for their liquidity provision (SEC).
When a trader in a dark pool or other undisplayed market center moves a fraction of a cent in front of a limit order that is shown, they are engaging in sub-penny trading and earning the spread. The seller loses the chance to fulfil the order, the buyer gets a better rate, and the liquidity provider doesn’t get any discounts.
Because they can guarantee the best pricing for their clients even when the deal is not on an exchange or ECN, retail brokers accept sub-penny orders. A broker’s commission frequently includes the access charge, thus they have an incentive to discover orders that do not necessarily pay these costs.
New Rules and Regulations
In order to remedy the increment issue, the SEC issued Rule 612, sometimes known as the Sub-Penny Rule, in 2005. The guideline specifically stipulates that equities over $1.00 must have a minimum price increase of $0.01, whereas stocks under $1.00 might have a minimum price increment of $0.0001.
The practice of sub-penny trading continued after the new regulation was implemented in the off-exchange markets since the rule prohibited sub-penny quotation but not sub-penny trading.
The general assumption at the time Rule 612 was introduced in 2005 was that price increments of $0.0001 were economically inconsequential and that only affluent investors would take advantage of these tiny increments to outperform regular investors. Others countered that technology wasn’t sufficiently developed to support a rise in on-exchange quotation for trading at penny increments.
The SEC published a report in 2015 that recommended for the widening of ticks or increments, but no changes were made until June 2022, when Gary Gensler, the chair of the SEC, spoke about the future of trading in sub-pennies on exchanges, including standardized tick size across various market centers.
Gensler is considering the potential of reducing the minimum tick size to more closely match off-exchange activity in light of the magnitude of off-exchange sub-penny trading.
How Does a Sub-Penny Trade Work?
Consider a scenario where a retail investor wants to sell 1000 shares of a stock at a stated price of.75 x.76, which is now only possible on light exchanges or dark pools. A rival market maker places a sell limit order at.75 but has a concealed offer of.7510 for 1000 shares. When the client places the sell order, the secret bid purchases the 1000 shares, and the customer gets filled at.7510 on the 1000 shares rather than the.75 price that would be displayed in a market that is subject to exchange regulations.
Where Can I Buy Sub-Penny Stocks?
Although the SEC is considering revisions in 2022 to allow the trading of penny stocks on regulated exchanges, penny stock trading now exclusively takes place on dark pool markets, which are secret exchanges for trading securities that are not available to the general public.
Is Sub-Penny Trading Regulated?
Trading for pennies and less is currently unregulated and takes place in a hidden market.
Bids floated by brokers, dealers, and high-frequency traders are referred to as “sub-pennying.”
They frequently override a limit order with a concealed bid that is a tiny bit better.
They do this to complete their deals first, providing bidders the best opportunity to profit from the spread.
