APRIL 2023 – ISSUE 14

The Lopsided Trading Smile

How Investment Product Unit Pricing Distorts Daily Trading Volume

Reporting Season

For many years, no self-respecting financial markets participant would take a call when the market opened. For the Australian Securities Exchange (ASX) this is 10.00 am (AEST) on weekdays. All trade indications are placed into what the ASX calls a Pre-open from 7.00 am until 10.00 am. The banter between market participants was expected before 9.55 am (AEST) but for the next 15 minutes, it was all business resulting from the ASX opening at staggered alphabetical intervals until 9.10 am (AEST). Whilst the opening auction for listed securities is still important for initial daily price discovery, this is not where the daily volume action lies.

The Opening Smile

After initial price discovery at the open, trade meanders through the day, volume is light and price moves (without any news shocks) are limited.

The Intraday Smile

Normal trading on the ASX closes at 4.00 pm (AEST) – however significant market volume has moved to the closing price auctions which are after normal trading on the ASX has closed. The ASX calls this the “Closing Single Price Auction”, which occurs between 4.10 pm and 4.11 pm (AEST) (+/- 60 seconds).

For market participants, this is known as the “Chocolate Wheel” i- a random closing auction time and sometimes random closing auction price.

The Closing Smile

More interestingly though – why is this now the case?

The answer lies in the timing of investment product pricing, margin pricing, swap pricing, collateral pricing, ETF pricing, and the daily reported price of many other investment instruments. So much of the investment supermarket is priced and therefore valued at the price that is reported as the closing price of the day. This has become more prevalent with the rise of index fund investing. The value of unquoted index funds is decided on the price of their individual constituents at the market close. This is no different for unquoted non-index funds, however, an index fund is blind to the intra-day price moves of the individual index constituents, whilst an actively traded fund watches intraday price and volume movement closely.

The move to lower intra-day trading volumes as trading volume has moved to the opening and closing auctions has led to what is known as a trading smile, for a while opening and closing volumes were similar as in initial price discovery attracted heavy volume, but now whilst volume is solid on the open, more volume has moved to the close and as such we now have a lopsided trading smile.

source: Platypus, Bloomberg, Macquarie Bank.

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