End Of Day MOC Volatility

Interesting article by FT Alphaville detailing the MOC (market on close) process.  I knew a couple traders who exclusively traded MOCs around the time of the financial crisis (and made millions) because the edge was so huge.  No surprise that bigger funds would seek to manipulate this process.

I’ve noticed that the bigger imbalances have a high positive correlation with the market direction after 3:40 and can sometimes account for a good portion of the daily move.

Anyone following the markets will know that end-of-day volatility has been a problem since at least the 2008 crisis.

Despite that, it’s only in the last month that mainstream pundits have begun to look more closely at the issue, arguing in most cases that the volatility results from the rebalancing activities of leveraged and inverse exchange-traded funds.

On this blog we’ve argued that it’s unlikely to be the fault of leveraged and inverse funds alone. Rather, that the volatility may be connected to the ETF industry’s general overuse of market-on-close (MOC) orders and limit-on-close (LOC)  orders.

The MOC mechanism, for example, allows intermediaries to buy or sell throughout the day at whatever the day’s closing price is, despite not knowing what it will be, while the LOC mechanism allows participants to submit orders at known prices into the close, safe in the knowledge that they will only be filled at the closing price or better.  Whether filled or not, these prices may still be used to determine closing prices.

Both processes are highly dependent on the workings of the daily closing auction.

As far as we understand it, on the NYSE Arca, the process goes like this.

The closing auction uses a single-price Dutch auction strategy, in which the seller gradually lowers his price until all stock is transacted. All bids higher or at the final auction-price ultimately receive the final price. Thus if there is an imbalance of more sellers than buyers, the average buyer will achieve a much lower price than what he might otherwise receive outside of the auction. If there are more buyers than sellers, the price in the closing auction will likely reflect a higher price.

Click HERE to read the entire article.

Source: The 15:00, 15:50 and 15:59 effect (FT Alphaville)

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