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An Explanation for Those Nasdaq's Wide Spreads

October 30, 1994

I have been an equity institutional salesman most of my 27 years at Smith Barney. The reason for wide OTC spreads on the Nasdaq ("Is This a Fair Trade?" Oct. 20) is obvious to anyone who works in that market every day. Institutional investors insist that market makers be good for a minimum number of shares at their bid and ask prices. The minimum is 10,000 shares for most stocks.

Market makers are afraid to make a bid or ask inside that spread, even to accommodate a client order, for fear of getting hit for the 10,000 shares. Since most traders have dozens of stocks they are trading at once, they program their computers to automatically adjust their bids and asks to the mean unless they have a large position to move. Surely you've noticed OTC stocks running up and down substantially without any trades as the computers follow the leader.

By contrast, you have the New York Stock Exchange auction system where any client can place an order on the specialist's book for any number of shares at any price. If a client enters 100 shares, he is only obligated to trade 100 shares.

The result is that the NYSE's auction quotes are tighter but thin. The OTC market maker's quotes are wide and deep for many institutional clients. The small OTC investor is left with a wide spread and no one willing to represent his order between the bid and ask.

The obvious solution is to have Nasdaq reprogram its computers to quote "net" (size) prices and "agency" (auction) markets separately, or with some kind of code. A client could then direct his broker to enter his order on the "agent" system. Although this system wouldn't prevent "trading through," it would allow clients to deal with each other without exposing the market makers to the additional risk that increases spreads. Such a system already exists on the NYSE. It is called 19C3 trading. Let's face it, today's computer systems make a Nasdaq market maker system look like the Model T.

BOB HETRICK, Santa Monica

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