One hundred is a lot of shares. Literally, when trading stock one “lot” is defined as 100 shares. A round lot is any number of shares evenly divisible by 100, while any other amount is considered an “odd lot.” Block traders do not deal in lots of shares. They operate on a scale several orders of magnitude larger.
Simply put, a block trade is the exchange of a very large number of financial assets.
Neither Congress nor the SEC have issued a legal definition of a block trade, and the term is often used casually. Most markets, however, have their own rules defining what constitutes a “block.” In practice most people default to the New York Stock Exchange’s Rule 127.10. This defines a block trade as one which involves at least 10,000 shares of stock or a market value of $200,000, whichever is less. Generally, this means that most investors consider a block trade as any exchange involving at least 10,000 units of the traded asset or at least $200,000 worth of that asset. For example, that could be 10,000 shares of stock or $200,000 worth of bonds.
Most block trades involve considerably larger amounts than this. Furthermore, while investors can technically conduct block trades on any financial market, most block trades involve either shares of stock or bonds. As a result, most block trading concerns the equity and debt markets.
Block trading is almost always conducted by institutional investors such as funds or corporations. Mainly, this is because the volumes involved price all but the wealthiest individual investors out of the practice.Why Do Block Trades Matter?
From the traders’ point of view, block trading is a way to move large amounts of a security without its market price changing during the process. If a hedge fund, for example, wanted to sell 1 million shares of a given company, doing so in parcels of 5,000 shares apiece would take time. During the course of those many trades (200 to be exact) the price of that stock could move, narrowing their expected profit margin. This is not to mention any potential issues involved with finding that many buyers for the same stock in a short amount of time.
Block trading eliminates that risk, letting the fund sell all 1 million of its shares simultaneously and at a single price.Block Trades and Market Volatility
From a market standpoint, block trades can also promote instability. Sudden, large movements in a given asset can cause sudden price swings. This is bad enough when it promotes volatility in the market. It’st far worse given that the price movement may be unrelated to that security’s value.
Take our example above. It’s possible that the fund might simply want to diversify its portfolio and has chosen that stock to sell in favor of another. However, the open market would see 1 million shares go up for sale all at once. That could this stock’s price down as the market takes this for weakness in the underlying stock.
That would promote volatility in the market and inaccurate pricing in the stock. Also, it could cause the hedge fund to get progressively worse prices for its lots of shares. This last phenomenon is known as “slippage.” If the hedge fund posts 1 million shares for sale, someone might buy the first 10,000 at their initial price. Then the price might fall before the hedge fund can sell its next set of 10,000 shares, and fall further before it sells the following set. As the sale goes on, the price only gets lower.
This is why major financial markets have rules specifically addressing the issue.Block Trading and Block Houses
Most block trades are conducted outside of the market. This is what is known as “over the counter” trading. Such trades occur when the two parties deal directly rather than through a dedicated financial market. In an over the counter trade the parties are free to agree upon any price they choose. However, most will settle on a price at or near the one posted on the marketplace.
For example, say you wanted to sell 1 share of stock to your friend Susan. You could literally sell her your share directly and take cash in exchange for the stock certificate. This would be an over the counter trade.
This is how traders conduct block trades. Occasionally block trades involve wo parties contacting each other directly and arranging to make an exchange for an agreed-upon price. However most of the time they place trades through a blockhouse. That is an institution which sets up large scale trades outside of the ordinary financial market. For example, it might facilitate trades of 1 million shares of stock off the New York Stock Exchange to prevent that sale from causing volatility in the market.
A blockhouse will pair a buyer and seller, negotiate a price, and facilitate a trade. In cases where the amounts differ, the blockhouse can help create parcels of a security. For example, if our hedge fund wants to sell 1 million shares of stock, the blockhouse might find a single, major buyer. However, it might find 10 buyers for 100,000 shares each.The Bottom Line
A block trade is a transaction involving a large number of securities. Two parties trade a vast number of equities or bonds at an arranged price.
Block trades often occur outside of open markets to decrease volatility and stabilize the price of the security. Generally, block trades require more than 10,000 shares of stock (but not penny stocks) or $200,000 worth of bonds. In truth, block trades are typically far larger than 10,000 shares.Stock Trading Tips
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