What are Block Trades?
Anytime there is an order for 10,000 shares or $200,000 worth of a single equity (excluding penny stocks), it is considered to be a block trade, or a block order. In many cases these types of trades are placed by institutional investors, such as a hedge fund manager who has a large portfolio worth tens or hundreds of millions of dollars. When a trader or manager of this size needs to unload a large parcel of shares quickly, they might sell them immediately at a discount, called a blockage discount. A block order isn’t only used to sell securities, they can also be used when buying a security. This can help to support the price of a security, or even push it higher if the block trade is large enough compared with the typical trading volume of the specific security.
Block trades can be handed off to an intermediary, or they are entered via a special system that assigns an average price per share to the trade, which is the weighted price of all the executions required to completely fill the order. The party doing the buying or selling maintains control over how the order is entered, or they can direct their intermediary on how to conduct the trade. However, it is important to remember that these large trades may not always get the price desired or the number of shares because they can significantly impact the price of the security.
In many cases a block trade will be executed off the exchange, over the counter, but the trade must still be reported to the exchange. For example, a fund may want to sell 50,000 shares of Apple, and another fund may be willing to buy these shares. The two are able to conduct this transaction off the exchange. It’s even possible to simply post their intent either with an intermediary or on a dark pool, and a match can be found in this way. In either case the two parties agree on the price for the transaction. When this transaction occurs outside the exchange it is still required by law to report the transaction to the exchange in a timely manner.
The intermediaries used for block trades are often referred to as block houses. These block houses may find an interested party to take the other side of any transaction, or they could break it up into a series of smaller orders, which are then sent to the electronic communication networks, or directly to multiple brokerages. By breaking the block trade up in this way, they are obfuscating the actual size of the order, and the entity that originated the order. They can also send these orders out at different prices and at different times in order to minimize the impact of the order on market prices.
Understanding Block Trades
Because of the massive size of block trades, they are rarely, if ever, made by individual investors. In practice block trades are almost exclusively the result of a large fund or trading desk buying and selling large amounts of shares or bonds, typically through the Wall Street investment banks or through some other intermediary.
When a block trade is conducted on an exchange in the open market the traders need to use caution because the large size of the trade can have a massive impact on the trading volumes and the price of the shares or bonds being traded. This is why an intermediary is almost always used to conduct block trades rather than the fund or trading desk buying and selling the securities directly on the exchange as they would with smaller amounts.
How Block Trades Are Made
As mentioned above, typically a block trade is made through an intermediary, known as a block house. These are firms that specialize in the purchase and sale of large blocks of securities. Because they specialize in this, they are able to initiate large block trades carefully, and can often avoid triggering volatility and a large rise or fall in the price of the security. Block houses have traders who have a great deal of knowledge and experience when it comes to executing and managing large trades. They also typically have special relationships with other block houses, brokers, and trading desks that makes it easier for them to trade these large blocks of securities without having an impact on price.
When a fund or other large trader is ready to conduct a block trade, they will typically reach out to contact the block house, presuming that they will be able to broker the best deal for the large trade. After the order has been placed the staff at the block house begin contacting those brokers and traders that specialize in the particular security being bought or sold. Typically, the order will be filled in smaller blocks with several buyers or sellers. In many cases this also involves special orders called iceberg orders which mask the actual size of the complete order.
Block Trade Example
Let’s presume that a hedge fund manager needs to sell one million shares of Tesla. The current average daily volume for Tesla is around 4 million shares. That means trying to sell all the shares at once would likely trigger a sharp drop in price, since it would represent 25% of the usual volume in TSLA shares. That means a market order, or even a limit order or iceberg order is not going to work in this case.
Instead the hedge fund manager reaches out to a block house he is used to working with and asks them to handle the transaction. The block house, who knows of other large buyers and sellers in Tesla shares, could possibly know a buyer or a number of buyers who are interested in the shares. In such a case the block house could negotiate a price that’s agreeable to both parties and execute the trade off the exchange, where it won’t have any impact on the market price of TSLA.
If the block house is unable to find a matching buyer to sell the shares off the exchange, they could also try the dark pool. Because dark pools only show that there’s an order, but not how many shares are in the order, the block house is free to post this large block of shares and it can freely interact with opposing buy orders in the dark pool. This might handle all the shares, or the block house could further break up the order and post it to other ECNs and brokers at different times and different prices in order to hide the actual size of the order and the identity of the seller.
Let’s assume that a stock is trading at $120 when the order is placed to sell the one million shares. By breaking the order up into smaller chunks, the block house is able to sell all the shares at an average price of $119.50 a share. Because the order was broken into smaller chunks and distributed across many brokers and ECNs it had a far smaller impact on the market price of that stock than it might have otherwise.
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