It's interesting you mention several MM's making a market in a single security and the spread acting as a cushioning zone. I don't think it's a cushion because the MM wouldn't get any business if their spread was out of line with the other MM's. To ensure you get the best deal possible from the MM that has the best price, this is how it works:
At any time during the day, a MM can feed into NASDAQ the price at which he is willing to buy a particular stock and the price at which he is willing to sell it, changing these quotations during the day as competition dictates. NASDAQ records all these thousands of different entries in its memory bank. Whenever a dealer wants to know at what price other dealers will buy or sell a stock, he simply turns to his NASDAQ machine.
NASDAQ provides different levels of service. Level 1 is a quote machine for the use of securities salesmen. Simply by pushing buttons for the alphabetical symbol of the stock on his desk-model machine, the salesman can get a "representative bid" price and a "representative ask" price on that stock. The representative bid is the median wholesale bid of all the firms making a market in the stock. Thus, if five dealers quoted bids on a particular stock at 20, 20 1/4, 20 1/2, 20 3/4 and 21, the representative bid would be 20 1/2.
If a customer finds a representative quotation to his liking, he may decide to make a purchase or a sale. With the order in hand, the salesman now turns to the Level 2 machine in the trading department. Again, by punching out the stock symbol, he gets the actual quotes of five firms making a market in the stock. The names of those firms are shown beside their quotes on the screen. There may be fewer than five MM's in the stock, but if there are more than five, the indication MOR appears on the screen. When the MOR button is pushed, the bid-and-asked quotes of the additional dealers, ranked in order of best price, appear. Once a trader knows what firm offers the best quotation, he contacts that MM by phone or wire and concludes the purchase of sale in the usual manner. All trades in OTC securities are settled and cleared through the "National Clearing Corporation (N.C.C.), a wholly owned subsidiary of the N.A.S.D. The N.C.C. has facilities in numerous major cities to serve hundreds of clearing members.
The N.A.S.D. does not attempt to dictate what the spread should be between bid/asked prices on any stock. It leaves that to be determined by the competition of the marketplace. But, the automatic quotation system is geared so that each time a MM enters a bid/asked quotation it is checked by computer again the "representative spread". If this representative spread is half a point and the MM enters a spread that is a point or more, he is notified instantly that his spread is excessive. This report of excess spread is forwarded from the computer to the N.A.S.D., which may then take disciplinary action against the MM.
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cuz bid/ask is usually from different MMs. rather, the spread protects the MMs offer and act as a cushioning zone to minimize their risk. |
