What Is a Stub Quote?
A stub quote, also known as a placeholder quote, is an order to buy or sell shares that is deliberately set far lower or higher than the prevailing market price. Stub quotes are used by market makers who wish to fulfill their liquidity obligations without intending for their orders to be executed.
- Stub quotes are limit orders placed far above or below a stock's current market price and are not intended to be immediately executed.
- They are generally used by market makers in order to fulfill regulatory requirements of posting continuous two-sided markets.
- On rare occasions, stub quotes can affect the market, such as in the case of the May 2010 Flash Crash.
- Since November 2010, the SEC has taken steps to reduce the practice of stub quotes.
How Stub Quotes Work
Stub quotes are used by market makers who are required to buy and sell shares of a security but do not want to do so at its current market price. In this situation, market makers can enter stub quotes that are so far from the prevailing market price that they are unlikely to be accepted by other market participants.
Market makers and specialists are required by the exchanges they participate in to make continuous two-sided markets (i.e., a two-way quote with both a bid and an offer) in order to provide liquidity in the names they are active in. The stub quote allows a market maker to fulfill this duty, but in a non-committal way, which can be frowned upon.
To illustrate, suppose ABC Trading is a market maker for Example Corporation, whose stock is currently trading with a bid-ask spread of $40 to $40.50 per share. As a market maker, ABC Trading is required to buy and sell a certain amount of Example Corporation stock each day. However, if ABC Trading does not want to increase its exposure to Example Corporation stock, it might circumvent its obligation by offering shares at a bid-ask spread that is far away from the best available market price, such as $4.00 to $405 per share.
Real-World Example of Stub Quotes
Typically, stub quotes would never be executed by the market. However, they can affect the market on rare occasions. For example, stub quotes are generally regarded as having contributed to the Flash Crash of May 2010. On that day, the Dow Jones Industrial Average dropped nearly 1,000 points due in part to the fact that stub quotes entered by market makers were inadvertently triggered during the day’s decline. A report from the Commodity Futures Trading Commission (CFTC) in 2014 described the Flash Crash of May 2010 as one of the most turbulent periods in the history of financial markets.
In November 2010, the U.S. Securities and Exchange Commission (SEC) announced new regulations scaling back the use of stub quotes by market makers. The new regulations require market makers to issue quotes that are within a certain percentage of the best available market price, which is known as the national best bid and offer (NBBO). Depending on the circumstances, these quotes might be allowed to deviate by as much as 30% or as little as 8%. These rules have been in effect since December 2010.