Volatility Trading Pauses

The outline's volatility trading pause (VTP) is the Plan's trading pause. A FINRA member sees the Plan twice: through the Limit Up-Limit Down compliance rule, which puts the duty on its own systems, and through the resumption conditions that decide when it may trade again.

What Must a Trading Center's Policies and Procedures Prevent?

A member that is a trading center in a national market system (NMS) stock shall establish, maintain and enforce written policies and procedures reasonably designed to comply with the requirements of the Limit Up-Limit Down (LULD) Plan, and specifically to prevent three things:

• The execution of trades at prices below the lower price band or above the upper price band for an NMS stock, except as permitted under the Plan;
• The display of offers below the lower price band and bids above the upper price band for an NMS stock; and
• The execution of trades in an NMS stock during a trading pause; however, bids and offers may be displayed during a trading pause, as permitted under the Plan.

The Plan itself puts the same duty on all trading centers in NMS stocks, including both those operated by Participants and those operated by members of Participants, whose written policies and procedures must be reasonably designed to comply with the limit up-limit down requirements and to comply with the trading pauses.

Exam Tip: Gotchas

• A pause stops executions and not displays. The rule expressly allows bids and offers to be displayed during a trading pause, as permitted under the Plan, so an answer banning all quoting is wrong.
• The band rules treat trading and display differently. Trades are barred outside the bands except as the Plan permits, while the display duty is aimed at offers below the lower band and bids above the upper band.

Which Transactions Are Excluded From the Price Band Limitation?

Two carve-outs sit inside the trade limitation:

• Single-priced opening, reopening and closing transactions on the primary listing exchange are excluded from the limitation.
• Any transaction that meets both of two conditions is excluded: it does not update the last sale price, except if solely because the transaction was reported late or because it was an odd-lot sized transaction; and it is excepted or exempt from the order protection rule.

Exam Tip: Gotchas

• The second carve-out is conjunctive and its own exception is narrow. A transaction that fails to update the last sale price only because it printed late, or only because it was odd-lot sized, does not qualify on that limb at all.

Which Stocks Are in Tier 1 and Which in Tier 2?

Tier 1 includes all NMS stocks in the S&P 500 Index and the Russell 1000 Index, plus the exchange-traded products (ETPs) identified in a schedule to the Plan's appendix.

Leveraged ETPs are excluded from that list.

Tier 2 includes all NMS stocks other than those in Tier 1, provided, however, that all rights and warrants are excluded from the Plan.

Regular trading hours run from 9:30 a.m. to 4 p.m. Eastern Time, or such other time as the procedures established under the order execution disclosure rule set, and under the Plan can end earlier than 4:00 p.m. in the case of an early scheduled close.

Exam Tip: Gotchas

• Rights and warrants are outside the Plan entirely. They are not simply Tier 2; the proviso excludes them from the Plan.
• A leveraged product can be a Tier 2 stock but never a Tier 1 stock. The exclusion applies to the Tier 1 eligibility list, and Tier 2 has its own treatment for a leveraged product.

What Are the Percentage Parameters?

For a Tier 2 NMS stock that is a leveraged ETP, the applicable parameter above is multiplied by the leverage ratio of the product.

The reference price used to decide which parameter applies during a trading day is the closing price of the NMS stock on the primary listing exchange on the previous trading day, or, if no closing price exists, the last sale on the primary listing exchange reported by the processor. That rule is the same for both tiers.

Exam Tip: Gotchas

• Two different reference prices are in play. One decides which percentage applies for the day and comes from yesterday's close; the other is the moving five-minute mean the bands are actually calculated from.
• The lowest price tier is a lesser-of test, not a flat percentage. Below $0.75 the parameter is the lesser of $0.15 or 75% in both tiers, except that for a Tier 2 stock that is a leveraged ETP it is that parameter multiplied by the leverage ratio of the product.

How Is the Reference Price Calculated and Updated?

The processor for each NMS stock calculates and disseminates to the public a lower price band and an upper price band during regular trading hours.

The bands rest on a reference price equal to the arithmetic mean price of eligible reported transactions over the immediately preceding five-minute period, except for periods following openings and reopenings. If no eligible reported transactions have occurred over that period, the previous reference price remains in effect.

Eligible reported transactions has the meaning the Plan's operating committee prescribes, and generally means transactions eligible to update the last sale price of an NMS stock.

The lower band is a percentage parameter below the reference price and the upper band the same parameter above it.

Doubling. Between 3:35 p.m. and 4:00 p.m. Eastern Time, or, on an early scheduled close, during the last 25 minutes of trading before it, the bands are calculated by applying double the percentage parameters, for all Tier 1 NMS stocks and for Tier 2 NMS stocks priced equal to or below $3.00.

Tripling. Where the primary listing exchange notifies the processor that it is unable to reopen an NMS stock due to a systems or technology issue and it has not declared a regulatory halt, the processor calculates and disseminates bands applying triple the percentage parameters for the first 30 seconds those bands are disseminated.

The update trigger. The processor calculates a pro-forma reference price continuously during regular trading hours. While that price has not moved by 1% or more from the reference price currently in effect, no new bands are disseminated and the current reference price stays effective. When it has moved by 1% or more, it becomes the reference price and the processor disseminates new bands, provided, however, that each new reference price shall remain in effect for at least 30 seconds.

Where the processor has not yet disseminated bands but a reference price is available, a trading center may calculate and apply its own bands from the same reference price the processor would use, until it receives bands from the processor.

Exam Tip: Gotchas

• A quiet five minutes does not blank the bands. With no eligible reported transactions in the period, the previous reference price simply stays in effect.
• Doubling and tripling apply in different situations and to different populations. Doubling is a clock rule covering all Tier 1 stocks and Tier 2 stocks priced equal to or below $3.00; tripling is a thirty-second response to a primary listing exchange that notifies the processor it cannot reopen because of a systems or technology issue and has not declared a regulatory halt.
• The 1% test and the thirty-second floor work together. A move of 1% or more sets a new reference price, and that new price must then hold for at least thirty seconds before another can replace it.

What Is the First Reference Price of a Trading Day?

Except when a regulatory halt is in effect at the start of regular trading hours, the first reference price for a trading day is the opening price on the primary listing exchange, if that opening price occurs less than five minutes after the start of regular trading hours.

The opening price is the price of a transaction that opens trading on the primary listing exchange. If the primary listing exchange opens with quotations, the opening price instead means the closing price of the NMS stock on that exchange on the previous trading day, or, if no such closing price exists, the last sale on that exchange.

During the period less than five minutes after the opening price, the pro-forma reference price is updated continuously as the arithmetic mean of eligible reported transactions following the opening price, including the opening price, and it becomes the new reference price if it differs from the current one by 1% or more, again subject to the thirty-second minimum.

If the opening price does not occur within five minutes after the start of regular trading hours, the first reference price is the arithmetic mean price of eligible reported transactions over the preceding five minute time period.

Exam Tip: Gotchas

• An opening with quotations does not produce a midpoint. For the opening price the quotation branch uses the previous day's closing price, or the last sale; it is the reopening price that uses the midpoint of quotations.

What Reference Price Follows a Pause or a Regulatory Halt?

Following a trading pause, and where the primary listing exchange has not declared a regulatory halt, the next reference price depends on how the exchange reopens:

• Where it reopens with a transaction or quotation that does not include a zero bid or zero offer, the next reference price is the reopening price on that exchange. The reopening price is the price of a transaction that reopens trading on the primary listing exchange following a trading pause or a regulatory halt, or, if the exchange reopens with quotations, the midpoint of those quotations.
• Where it notifies the processor that it is unable to reopen due to a systems or technology issue, or reopens with a quotation that has a zero bid or zero offer, or both, the next reference price is the last effective price band that was in a limit state before the trading pause.

That notification is itself a duty. The primary listing exchange shall notify the processor if it is unable to reopen trading in an NMS stock due to a systems or technology issue and has not declared a regulatory halt, and the processor disseminates that information to the public.

Following a regulatory halt, the next reference price is the opening or reopening price on the primary listing exchange if that price occurs within five minutes after the end of the halt. If it has not occurred within that time, the reference price is the arithmetic mean price of eligible reported transactions over the preceding five minute time period.

The processor updates the bands after receiving one of three notifications from the primary listing exchange: a reopening price following the trading pause; a resume message, where the reopening quote has a zero bid or zero offer, or both; or notice that it is unable to reopen following the pause due to a systems or technology issue.

Provided that where the primary listing exchange is unable to reopen due to a systems or technology issue, the update to the price bands will be no earlier than ten minutes after the beginning of the trading pause.

Exam Tip: Gotchas

• A zero bid or zero offer on the reopening quotation flips the reference price source. The stock does not get a reopening price; it gets the last effective band that was in a limit state.

How Are Off-Band and Limit State Quotations Flagged?

The processor flags quotations rather than suppressing them:

• Where the national best bid is below the lower price band, or the national best offer is above the upper price band, the processor disseminates it with an appropriate flag identifying it as non-executable.
• Where the national best offer equals the lower price band, or the national best bid equals the upper price band, the processor distributes it with a flag identifying it as a limit state quotation.

An off-band offer or bid submitted despite the required reasonable policies and procedures is still disseminated with a non-executable flag. Provided, however, that any such bid or offer shall not be included in national best bid or national best offer calculations.

Exam Tip: Gotchas

• Equalling a band and passing through it produce different flags. A quotation that equals the opposite band is a limit state quotation; one that is beyond its own band is flagged non-executable.
• Not every non-executable flag removes a quotation from the inside market. A national best bid below the lower price band, or a national best offer above the upper price band, is still disseminated as the national best bid or offer. Only an off-band offer or bid submitted despite the required policies and procedures is kept out of the national best bid and offer calculation.

How Does a Stock Enter and Exit a Limit State?

All trading in an NMS stock immediately enters a limit state if either of these is true:

• The national best offer equals the lower price band and does not cross the national best bid; or
• The national best bid equals the upper price band and does not cross the national best offer.

On entry, the processor disseminates that information by identifying the relevant quotation as a limit state quotation. At that point the processor ceases calculating and disseminating updated reference prices and price bands until either trading exits the limit state or trading resumes with an opening or reopening.

Trading exits the limit state if, within 15 seconds of entering it, the entire size of all limit state quotations is executed or cancelled.

Where trading exits within that time, the processor immediately calculates and disseminates updated price bands on a reference price equal to the arithmetic mean price of eligible reported transactions over the immediately preceding five-minute period, including the period of the limit state.

Where trading does not exit within 15 seconds of entry, the limit state terminates when the primary listing exchange declares a trading pause, or at the end of regular trading hours.

Exam Tip: Gotchas

• A limit state ends in one of three ways, and only one of them is a pause. It can clear in fifteen seconds, it can end with a declared trading pause, or it can run out at the close.
• The recalculated reference price counts the limit state itself. The five-minute mean includes the period of the limit state, rather than skipping it.

When Must, and When May, the Primary Listing Exchange Declare a Trading Pause?

If trading in an NMS stock does not exit a limit state within 15 seconds of entry during regular trading hours, the primary listing exchange shall declare a trading pause and shall notify the processor.

The exchange may also declare a trading pause when the stock is in a straddle state. A straddle state is when the national best bid is below the lower price band, or the national best offer is above the upper price band, and the stock is not in a limit state.

The discretionary pause also needs trading in that stock to deviate from normal trading characteristics such that declaring a pause would support the Plan's goal of addressing extraordinary market volatility.

Two duties attach to it. The exchange shall develop policies and procedures for determining when it would declare a pause in those circumstances, and shall notify the processor where it declares one under that provision.

The processor disseminates trading pause information to the public. No trades in an NMS stock shall occur during a trading pause, but all bids and offers may be displayed.

Exam Tip: Gotchas

• The straddle state pause is discretionary and the limit state pause is mandatory. The exchange may declare one in a straddle state; it shall declare one where a limit state runs past fifteen seconds.
• A straddle state is defined partly by what it is not. The stock must not be in a limit state, which is what separates it from the mandatory case.

How Does a Stock Reopen After a Trading Pause?

Five minutes after declaring a trading pause, and if it has not declared a regulatory halt, the primary listing exchange shall attempt to reopen trading using its established reopening procedures.

The processor publishes three things the exchange provides in connection with that reopening: the auction reference price, the auction collars, and the number of extensions to the reopening auction. The trading pause ends when the primary listing exchange reports a reopening price.

Trading centers may not resume trading in an NMS stock following a trading pause without price bands in that stock.

Exam Tip: Gotchas

• The pause ends on a reported reopening price, not on the five-minute mark. Five minutes is when the exchange must attempt to reopen, and the attempt can be extended.

What Happens to a Pause in the Last Ten Minutes of the Day?

Where an NMS stock is in a trading pause during the last ten minutes of trading before the end of regular trading hours, the primary listing exchange shall not reopen trading and shall attempt to execute a closing transaction using its established closing procedures. All trading centers may begin trading the stock when the primary listing exchange executes a closing transaction.

If the primary listing exchange does not execute a closing transaction within five minutes after the end of regular trading hours, all trading centers may begin trading the stock.

Exam Tip: Gotchas

• A late-day pause has no reopening auction at all. The exchange goes straight to a closing transaction, and trading centers wait on that print or on the five-minute backstop.

When May a Member Resume Off-Exchange Trading?

A member may not resume trading otherwise than on an exchange following a trading pause or a regulatory halt in an NMS stock subject to the Plan unless trading has commenced on the primary listing exchange and either:

• The member has received the price bands from the processor; or
• Where the processor has not yet disseminated bands but a reference price is available, the member calculates and applies price bands based on the same reference price the processor would use, until it receives bands from the processor.

Notwithstanding that paragraph, a member may resume trading otherwise than on an exchange where the primary listing exchange notifies the processor that it is unable to reopen the stock due to a systems or technology issue, or reopens with a quotation that has a zero bid or zero offer, or both, and both of these hold:

• The member has received the price bands from the processor; and
• Trading has commenced on at least one other national securities exchange.

The exchange-listed clearly erroneous rule borrows these percentage parameters for a transaction executed when price bands were unavailable, one that fell outside the bands through the member's own technology or systems issue, and one executed after the primary listing market declared a regulatory halt, suspension or pause.

Its multi-stock event provisions run on that rule's own numerical guidelines instead. Both are covered in the unit on identifying and handling clearly erroneous transactions.

Exam Tip: Gotchas

• The ordinary route and the exception invert the treatment of self-calculated bands. Ordinarily a member may act on bands it calculates itself; under the exception it must have received the bands from the processor.
• The exception still needs trading somewhere. It requires trading to have commenced on at least one other national securities exchange, which replaces the commencement on the primary listing exchange.

What Should You Check on Exam Day?

• Identify the tier and the price range first; the parameter, and whether the late-day doubling applies, both follow from them.
• Confirm the fifteen-second clock is measured from entry into the limit state, and that a mandatory pause follows only if the state does not clear.
• Check whether the reopening quotation carried a zero bid or offer; that switches the next reference price to the last effective band in a limit state.
• On resumption, ask whether the ordinary route or the unable-to-reopen exception applies; the exception requires processor bands and another exchange trading.
• Treat a pause as banning trades only; displayed bids and offers are expressly permitted as the Plan allows.