Building Belter
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COMMENTARY 72
HOW BIG IS THE STRIKE ZONE?
At the heart of Plexus Group's transaction cost measurement is the comparison of the "strike price" at
the time when the trade order became actionable to the transaction prices received in the marketplace.
The difference is the cost of implementing the order. In this spotlight, we discuss how Plexus establishes
a strike price, and present some ideas on how to set more representative strike prices.
Strike Prices
The financial management industry assigns great
prominence to markei prrces. Yet we all realize that
any historical price is no more than a snapshot or a
flicker of a volatile, dynamic process.
Suppose a portfolio manager forwards an order to
his trade desk on February 13th at forty seconds
after 1:30 in the afternoon. The implementation
shortfall methodology requires comparing price
movements between this point of initiation (the strike
price) and the ultimate execution prices. Should we
accept the bid, the ask, or the last print (13:30:40 on
2113102) as the best benchmark? Did the portfolio
manager really focus all of his intellectual power on
that particular instant? ln contrast, would some
appropriate sample of the concurrent stream of
prices result in a more representative strike price?
Years ago Plexus adopted a solution for this strike
price question that applied a "representative time
frame" approach. We knew - or could infer - the
time at which the order was presented to the buyside
trade desk, but we were concerned about the
representativeness of these flicker prices. Our
solution was to average prices surrounding the
moment of order release. Somewhat arbitrarily, we
chose a ten minute clock period during which the
order was received on the trade desk. Our loqic was
as follows:
1 . By using an averagewe minimize the effects of the
bouncing of prices between bid and asked.
2. We selected the volume weighted price for this
short time interval instead of the mid-spread price
because itwould tend toweigh the
Perf orm.rnGe
SEPTEMBER 2OO2
preponderance of buyers and sellers in the
market: When buyers were dominant, the volume
weighted price would likely be above the mid-
spread price.
3. Averaging dampens the pafticularly unstable
opening and closing prices.
4. The recording of time stamps into the order
management systems is often subject to small
random delays.
5. Most investment managers base their selections
on a threshold price, not on a specific momentary
orice.
6. Organizing our databases on a ten minute time
slice vastly accelerates data retrieval and reduces
storage requirements.
While ten minutes felt "about right," not everybody
buys into this logic. Some argue that ten minutes is
too long an intervalwhen markets are moving rapidly.
So we decided to re-examine our assumptions in the
light of new data capabilities at Plexus.
We looked into our new daily-updated databases of
tick data on the 8000+ most widely traded stocks on
the planet. We examined the dis-tribution of number
of trades per day across all companies. We then
expanded our investigation to focus on non-retail
trades greater than 1000 shares or 5000 shares per
trade.
The table shows the compiled information for the last
trading day in June, 2001. Any of the first three
columns can be read as a category. To illustrate,
consider the last line in the table. One company
(Cisco) recorded 52,455 trades that day, 874+ per
minute, or on average one every seven-hundredths
of a minute.
Suppose we were to
rebuild our average price
databases to include higher frequency data Elimi nating Retail Tradi ng
"buckets." Instead of ten minute buckets, we could
form one minute intervals on, say, every stock with One of the bothersome aspects of counting each
more than '1000 trades per day. In the table, this and every trade is we overstate the liquidity on
standard applies to the line describing the 1001-5000 companies such as the NASDAQ-Iisted
Trades Per Day. 1000 trades per day implies a trade companies that command a great deal of retail
every 5 seconds on average, or 12.5 per minute.
interest but little trading in institutional size. To
analyze the depth of institutional interest, we
Responsible statistical averaging requires a performed the same analysis, this time eliminating
respectable sample size. Plexus distrusts any trading
all trades less than 1000 shares.
statistic based on less than ten observations. Thus
twelve samples per minute, 5000 trades or more per
day, corresponds to this lower time interval to build The results clearly indicate how rapidly market
reasonable samples. liquidity thins out. Only nine stocks make the
twelve trades/min.
lfraximum Average
cutoff: NYSE, six
Traeies three NASDAQ, and
per
Trades min:sec #of Cum
NYSE NASDAQ NON.US
Day
per Between Stocks Pct zero non-US. The
Minute Trades names are Honey-
0.01 80:00 541 6.6 91 407 well (story stock of
6-1 0
1'1-50
0.03
0.13
40:00
8:00
Cqt
rsia,+
r o.g
2e.ri
65
328 1
2s3
005
the day), Exxon
5'l-100 0.25 4:00 934 +t.C 188
Mobil, Citigroup, No-
557
10'1-500 1.25 0;48 ittt 79.6 873 't280 kia, Global Crossing
501 -1 000 2.50 0:24 870 go.e 365 231 (story stock) AOL
1 001 -5000 12.50 0:05 odo 9S.3 297 199 Time Warner, Intel,
5001 -1 0000 25.00 0:2.4 se.s 36 12'
56
Oracle, and Cisco.)
qi gs.gs
1 0001 -50000
cz4c3 (max)
125.00
874.25
0:0.48
0:0.068 100.0
38 2
0
The number of
stocks with at
1 1
least
The table shows us that exactly 99 stocks, I NYSE, 1000 trades drops from 785 stocks to 190.
75 NASDAQ, and 15 non-US had 5000 trades or
more per day. Only 12% of the institutional universe
Our conclusion is thus even stronger than before.
has more than 5000 trades per day.
Focusing on only institutional sized trades over
Companies with lower trading frequencies require a
1000 shares, there are only a handful of com-
longer time interval (e.9. ten minutes or more) to panies with sufficient daia to justify shoi-ter
gather enough data for averaging. However, averaging intervals. lf we set a standard of at least
suppose that instead of cutting off at 5000 trades per 5000 trades per day to form rea-sonable
day, we cut off at 1000 trades. In this sample there averages, 10 minute or longer trade intervals are
are 785 stocks with more than 1000 trades per day; preferable for 99.9% of all stocks in our universe.
199 NYSE, 372 NASDAQ, and 214 non-US stocks. Against a standard of 1000 institutional trades per
Even by this loosened standard, 90% of the stocks day, a minimum of a 10 minute interval is required
trade so infrequently as to make an averaging for 9B.B% of the trading universe.
interval less than ten minutes questionable.

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