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Charlie (doing his usual provocative thing) wrote: However, the price and size are 93.051 x 325 (20/1).

Longreits (commendably) asked: I don't like asking other people questions I can answer myself, so I did some research online to try to figure out what this meant, and couldn't come up with an answer. I also looked at the quote sheet and couldn't make sense of it. Is 325 the # of bonds traded? Also, what is (20/1)?

Scott (ably and succinctly) replied: The 325 is the total number of bonds available at the posted price at this time at this broker's bond desk. The 20/1 represents a minimum buy of 20 bonds with 1 bond increments, i.e. you can't buy 1 bond, or 19, but you could buy 20, 21, 22, ... 325 at this broker's bond desk.

Now, let’s take the matter a bit further. Let’s talk about the whole quote line, using one of 11 bonds that was found when the scan parameters were Aaa or AAA and 5% or better YTM. At E*Trade, this is what you’ll see:


Order Qty Execution Issue Coupon Maturity Price Yield Moody/S&P
(Min/Incr) Type

Sell 2000 Firm Pfizer 6.200 03/15/2019 107.224 5.241 Aa2/AAA
Buy 500 108.279 5.108
(10/1)


The meaning of that information is self-evident. But let’s translate it anyway, using the explanation Scott provided. There are 500 of Pfizer's 6.2's of '19 for sale at a price of 108.279. The minimum purchase amount is 10 bonds. Also, 11 could be bought, or 12 or 43, but not 501.

Most likely, E*Trade isn’t holding the bonds in its own inventory. Instead, some underlying bond desk, somewhere, that has 500 of Pfizer’s 6’2’s of ’19 in its inventory is willing to sell them at a price of 108.279. That price is the “Offer” (or the “Ask”). E*Trade is merely re-quoting the underlying desk, because it wants to act as the intermediary to the trade and to make its money from charging a commission. Likely, the same lot of 500 could be purchased through several other online brokers, such as Vanguard, Schwab, Fidelity, Zions Direct, Scottrade, Ameritrade, Interactive Brokers, etc., plus all of the full-service firms, plus the boutiques. If any of them are also quoting the bonds, then a customer could buy the bonds through those brokers as well. Not all brokers quote corporates from as wide a network as E*Trade. This is part of what makes them a superior bond broker to deal with compared to Scottrade or Fidelity, etc.

On the other side of the market, the buy-side, there is someone, likely an institutional rather than an individual investor/trader (from the size of the order), that wants to buy 2000 of Pfizer’s 6.2’s of ’19 and is willing to pay 107.224. That price is the “Bid”. The difference between the Ask and the Bid is the Spread. With stocks, it’s possible to buy at the bid and sell at the ask, or in between (called, “splitting the spread”.) With bonds, it is also theoretically possible to gain price improvement”. But, practically speaking, the small investor will buying at the ask and selling at worse than the bid. (He won’t being selling in a size large enough to interest a buyer to pay the inside market price.)

ARRGH. This just gets worse the further I go. The more I try to explain about something that really is very simple, i.e., the dynamics of buying and selling bonds, the more new terminology I introduce and also have to explain.

"Inside market” is a term I’ve used before and explained before, but let’s reprise. The (secondary) corporate bond market isn’t a place. It’s a network of interconnected dealers much like the NASDAQ is for stocks. Within that network, bonds are quoted on the buy-side and the sell-side. The current, national best offer and bid (aka, the current lowest asking price and highest bid price) are the "inside market". Prices that are worse (higher offers and lower bids) are “outside” of that ”inside”. The “spread” is determined from the inside market, not from the extremes of “the book.

See? It happened again. Another new term popped up that has to be explained. (Which, actually, was my intention all along. ROTFL)

E*Trade, bless them, sometimes provides “the book” on a bond. In fact, that’s why I chose to use Pfizer’s 6.2s. The book is available, which I quote below. (actually, half the book, just the sell-side.)


Offers
Order Qty Min
Qty Price Yield Updated
Buy 500 10 108.279 5.108 09:58 am
Buy 485 2 108.828 5.039 09:46 am
Buy 328 2 108.868 5.034 09:55 am
Buy 85 2 108.884 5.032 10:02 am
Buy 100 2 108.894 5.031 09:45 am
Buy 135 2 109.569 4.947 09:58 am
Buy 1000 2 109.859 4.911 10:02 am


In the preceding, the lowest asking price is 108.279. That's the price in the queue that gets quoted on the order line. The rest of the queue is orders waiting to be executed. Most of them won't be acted on. They are too far from the market. In fact, most of them are probably just head fakes. Some desk, somewhere, is just screwing around. If a large-sized buyer were really interested in selling a lot of bonds, he wouldn't be publishing his intentions for fear of being "front run". He's have a large-order specialist work the order behind the scenes. Ditto on the buy side. So being able to see the book is mostly just fun, rather than informative. But it is a measure of E*Trade's professionalism that they make such info available to their customers.

To summarize: Guesses can be made about the fairness of prices from the sizes of the orders, the spread of the prices, the depth of the book, etc. But that’s more nerdy that most bond investors want to get into. So I won’t attempt to give my version of it. But the basics of a quote line shouldn’t be a mystery, and once you’ve looked a lot of them, translating them becomes easy. In another posts, I'll dig into other parts of the quote line. But this mini-lesson is enough for today.
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Thanks, Charlie. This is starting to make some sense. The dynamics of the bond market, and bond trading, fascinate me - why no central marketplace? Do you see any reason why the existing network of dealers would be supplanted by another system?

Thanks again.
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Do you see any reason why the existing network of dealers would be supplanted by another system?

LR,

I guessing hugely about this. But the world-wide trend –-not just the trend in the US-- is toward the elimination of out-cry exchanges in all markets in favor of electronic ones and the consolidation of exchanges. OTOH, there are always entrenched interests that resist reforms, plus the genuine obstacle of the start-up costs of making those reforms.

I’m not an informed observer of the bond market. I’m merely the smallest of small investors who has picked up a fact or two, because it interested me, or because I saw the need to do so. But from my limited perspective, I think the “bond market” --as it currently is-- works pretty well. I can get my business done. Yes, spreads and commissions are abusive compared to what is available in the stock market. But that’s the game, and that will continue to be the game until more people buy their own bonds. Once “critical mass” is achieved, some enterprising broker will break ranks and begin trying to serve those customers. In a sense, E*Trade is leading the way already. Their commission used to be $40/ticket. Now it’s $10, plus the trading platform they make available is superior to that of all other brokers, not that Fidelity doesn’t offer a few cute twists of its own. To the upside, there have also been huge changes in terms of how much historical price information is now available to bond investors. E.g., TRACE data from Investing in Bonds and FINRA.

Finally, a very clear distinction has to be made between bond trading (which I don’t do) and bond investing . Anyone who is serious about bond trading is going to be using a Bloomberg, not messing around with executing through a retail broker like E*Trade. They are going to use a direct-access broker or get themselves licensed as a market maker.

If you want a nerdy book that talks about exchange dynamics, take a look at Larry Harris, Trading & Exchanges: Market Microstructure for Practitioners. The focus of stock exchanges, but the info translates well enough to the dynamics of the bond market.

Charlie
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