Locked & Crossed Markets Explained

Understanding Locked and Crossed Markets

Recent discussions on market structure regulatory reforms have highlighted their implications for various market participants. A key focus during the recent Order Protection Rule roundtable was the role of the National Best Bid and Offer (NBBO).

Several participants inquired about locked and crossed markets, seeking clarity on their definitions, causes, and importance. This article delves into these phenomena, providing a comprehensive explanation of their relevance to investors.

Defining Locked and Crossed Markets

A locked market arises when the highest bid price equals the lowest offer price across different exchanges. For instance, if a buyer on one exchange is prepared to pay $10.00 and a seller on another is willing to accept $10.00, yet no transaction occurs, the market is locked.

A crossed market, on the other hand, emerges when the best bid exceeds the best offer. This could happen if a buyer bids $10.00 while a seller offers shares at $9.99, but trading still does not take place.

Under Rule 611 of Regulation NMS, known as the order protection rule, exchanges and trading venues must prevent trade-throughs. This regulation ensures that investors execute trades at the most favorable prices available nationwide, irrespective of the quoting exchange.

Additionally, Rule 610 mandates that exchanges displaying quotes avoid creating locked or crossed conditions through their quotations.

Nevertheless, the consolidated NBBO can still display locked or crossed states temporarily.

Data analysis of S&P 500 stocks reveals that each stock experiences an average lock duration of about 2.5 seconds daily. Crossed conditions are far rarer, averaging just 4.2 milliseconds per day.

The Influence of Bid-Ask Spreads

Not every stock behaves the same way. Evidence indicates that tick-constrained stocks—those limited by the minimum price increment—are prone to more frequent locking. Lower-priced stocks, which often feature tighter spreads, are particularly susceptible to tick constraints.

This pattern is logical, as such stocks operate near the locking threshold, typically with substantial order depth and extended queues compared to others.

Higher-priced stocks, conversely, maintain wider spreads spanning multiple ticks. Traders can adjust quotes by several ticks without reaching the opposite side, reducing the likelihood of locking.

This correlation suggests that the SEC’s proposal for half-cent ticks on tick-constrained stocks could significantly diminish instances of locked and crossed quotes in affected securities.

Duration of Locked Conditions

While locks and crosses do occur, their persistence is short-lived. Locked markets endure for an average of 5.5 milliseconds, and crossed markets resolve even faster at 0.8 milliseconds—brief periods, though not entirely negligible.

Latency Effects on SIP Feeds

Message transmission between venues takes approximately 0.2 milliseconds. Consequently, a lock or cross observed on the Securities Information Processor (SIP) may not reflect real-time conditions elsewhere due to propagation delays.

For example, although locked markets suggest arbitrage opportunities, rapid trader responses often eliminate crosses before orders can be routed and executed. Academic studies adjusting for fastest possible latencies confirm that many crossed conditions vanish quickly.

Research by Holden, Pierson, and Wu (2023) utilized SIP exchange timestamps to simulate NBBO views at key data center locations like Mahwah, Secaucus, and Carteret, accounting for latency. Their findings indicate an 80% reduction in matched trades to locked spreads, attributing much of the observed phenomenon to geographic delays.

Implications for Market Rules

As the SEC evaluates NBBO economics and some propose eliminating it entirely, such data provides critical context. Current mechanisms ensure rapid resolution of locks and crosses, often faster than human perception, thanks to efficient market makers and arbitrageurs.

The impact of removing the Order Protection Rule remains uncertain. Locks might increase if traders prioritize queue position over immediate execution to evade fees. This could also raise questions about the viability of midpoint pricing, price improvement, and related reporting metrics under new dynamics.

These considerations are vital for market participants and regulators as they reassess Regulation NMS.