Whether they know it or not, the brave few investors trading after hours can call themselves arbitrage capitalists. In theory, varying prices between competing after-hours exchanges allow them to exploit price discrepancies. Or, just as likely, be exploited by them.
The bad news for traders in the latter category is that the price discrepancies
last month still plague the extra session, and
plan to extend its quotation services -- and thus consolidate prices -- from 4 p.m. to 6:30 p.m. ET keeps getting put off.
The good news is that the discrepancies should be eliminated when the electronic communication networks (ECNs) consolidate their order books at year-end.
Meanwhile, there's no telling which ECN,
, will offer the better price for a stock on a given night.
tracked how stocks in the news traded last week in after-hours sessions and found that closing-price discrepancies for a given stock could amount to more than $500 on a 1,000-share trade, but there was no way to anticipate if and when they would occur.
After Monday's close,
reported third-quarter earnings that dusted analysts' estimates. Consequently, after-hours investors gobbled up shares of the Net marketing specialist. But if you bought your shares at Island's closing price of 96 13/16, rather than at MarketXT's 97 1/8, you'd have saved more than $300 on a 1,000-share trade. But no matter where you invested, you would have made money: The stock opened at 98 in the next morning's regular trading session.
Tuesday's action shows the late session's whimsy. Well after the day session ended, Web-site builder
was taking a $67.5 million stake in the firm. Investors traded 23,000 USWB shares on Island, and it was the seventh-most-active issue on the ECN that night. But you couldn't trade it on MarketXT because it wasn't one of the 100-most-active Nasdaq stocks during the day.
announced its new zShops, and investors went shopping for Amazon shares after hours. A hefty 190,908 shares changed hands on Island, compared with a modest 750 on MarketXT. But MarketXT was actually the place to be. You could have paid 50 cents less, or 80 1/2 per share, on MarketXT at the close. That's a $500 savings on a 1,000-share order. But no matter which ECN you used, you would have been in the red on your investment the next morning when the stock opened at 79 13/16.
Thursday produced the week's biggest price discrepancy. Piqued by
, investors scooped up shares of the Internet service provider on both ECNs. You could have saved more than $550 by buying the stock at Island's closing price of 44. If you bought the stock at MarketXT's closing price of 44 9/16, you were under water Friday morning when the stock opened regular trading at 44 1/16.
These price differences are the result of each ECN's independent status. Online brokers typically use one ECN to execute trades. Each ECN keeps an online record or order book on each stock it trades after hours. When a bid and ask price match up, the system executes the order. But since each ECN's order book is separate, each network can be a separate market for the same stock after hours -- each with its own price.
Compounding the problem is the wide volume discrepancy between the two ECNs. For an example, look no further than the Oct. 6 session where Island's most active name,
, traded 212,196 shares and the price rose 7 7/8 during the session, while MarketXT's top 10 stocks traded 10,425 shares combined. (And Yahoo! gained 9 1/4 on volume of 1,675 shares.) The difference is mostly due to the fact that Island has more than 200 broker/dealer subscribers, while MarketXT has only three.
Low volume has led to wider bid-ask spreads, particularly on MarketXT, where clients regularly see their trades go unexecuted. To remedy the situation, MarketXT uses liquidity providers, also known as market makers, who continuously provide buy and sell orders on a given stock, potentially tightening spreads.
But "there are still execution issues -- it doesn't say anywhere that an XT order will reflect a price on Island or Instinet," an ECN favored by institutional traders, says Mark Madoff, director of listed trading at
Bernard L. Madoff Securities
But Madoff says Nasdaq's proposed extension of its quotation services until 6:30 p.m. ET will help by offering traders on each system a view of prices on the other system. Still, it will cover only part of the after-hours action. Island and MarketXT offer trading until 8 p.m., and the MarketXT session doesn't even begin until 6 p.m.
Also, the Nasdaq extension is hardly a done deal. It was set to begin on Oct. 4, but was postponed until Monday awaiting
Securities and Exchange Commission
approval, which still hasn't been given. Beyond the regulatory delay, there are logistical issues. On Wednesday morning, a software change that would add after-hours ECN data slowed SelectNet to a crawl for several hours.
Nasdaq spokesman Wayne Lee says Oct. 11 is now the "tentative, working date" to begin, subject to SEC approval.
James Punishill, online brokerage analyst at Cambridge, Mass., technology research firm
, dismisses Nasdaq's consolidation efforts. "Nasdaq's extension is only until 6:30 p.m. anyway, so who cares? When the ECN linkage happens, then you'll have one national pricing system. That is what will solve the problem."
The much ballyhooed link-up, scheduled for year-end, would produce one consolidated order book among all major ECNs, including institutional heavyweight Instinet. Madoff says he's looking forward to it. "I won't have to jump between ECNs to check different quotes on the same stock."
Hopefully, investors will be able to say the same.