Rule 611 of Regulation NMS, also known as the Order Protection Rule, introduced Intermarket Sweep Orders (ISOs) -- e.g., the Immediate or Cancel (IOC) ISO -- that provide institutions a means to comply with trade-through rules while executing large orders that need to sweep through multiple levels of the order book across multiple market centers. However, as previously discussed, high-speed traders leverage ISOs for another reason : to get an edge over less sophisticated traders in fast moving markets, particularly those traders who rely on exchange mechanisms for compliance with Rule 611, mechanisms that expose orders to the adverse effects of slow Stock Information Provider (SIP)data feeds.
In addition to defining IOC ISOs, Rule 611 also introduced another ISO variant -- the seemingly non-controversial DAY ISO order type. In fact, the DAY ISO is anything but innocuous; rather, it is an essential HFT-oriented order type packed with advantages.
As with the case of IOC ISOs, high-speed traders employing DAY ISOs can gain access to prices that would normally be inaccessible to traders who rely on exchanges to comply with trade-through rules., The DAY ISO, however, combines all the advantages of IOC ISOs with powerful features that HFTs exploit to book orders at the top of the queue, capabilities that in fact trump the capabilities of most other HFT-oriented order types.
Originally, the DAY ISO was intended for institutions that wanted to sweep to a particular price level and then post at the best price – for example, clear the offer, then bid aggressively for more at the old offer price (buy all you can at the offer, then post a limit to buy the remainder at the old offer price). To use a DAY ISO, a broker-dealer is required either (a) to show it isn’t locking or crossing away markets, or (b) to sweep markets displaying prices it would otherwise lock or cross. Thus the DAY ISO order addresses conditions in which Regulation NMS puts constraints upon an order to simultaneously satisfy the ban on locked markets stipulated by Rule 610 and the trade-through rule stipulated by Rule 611.
However, the DAY ISO also provides a way to step ahead of orders that are already resting on the book -- orders that were originally submitted at the same price but were price-slid or hidden to comply with Rule 610 and the ban on locked markets. This advantage -- the remarkable ability to step ahead of orders resting on the book at the same price -- gives DAY ISOs a unique edge over the bulk of order types, including orders that “hide and light.”
Like orders that “hide and light,” the DAY ISO can be used by HFTs to lock away markets that are in fact stale phantom prices on the SIP feed that are no longer present on the away exchange. Unlike “hide and light” orders, though, the DAY ISO enters the market as a protected quotation and is eligible for immediate display on the book, whereas the “hide and light” order must remain in a hidden state until the away market unlocks. When sending a DAY ISO in such conditions, the burden of liability is on the HFT to demonstrate that the direct feeds used indeed show that away markets have truly faded and that there isn’t a pattern of locking protected quotations on away markets or any violation of Rule 610. If, for any reason, an HFT desires to lock an away market that displays a firm quotation (and not a phantom quotation) with a DAY ISO, the HFT would also have to take out the away market with an ISO. The other option in such a scenario would be to simply use a “hide and light” order.
DAY ISOs, like “hide and light” orders, avoid conditions that would normally result in rejection, rerouting, or disadvantaged price-sliding of aggressive orders -- unfavorable order treatment that typically occurs when an exchange employs a slow SIP feed to assert compliance with the ban on locked markets and the trade-through rule. Not only do HFTs exploit DAY ISOs to get ahead of slow SIP feeds while avoiding the disadvantaged exchange order handling treatment described above, HFTs also use DAY ISOs to step ahead of “hide and light” orders already resting on the book. What is most remarkable about DAY ISOs is this ability to queue jump orders that arrived at the exchange at the same price as, but prior in time to, the DAY ISO.
(For another example of price-time priority corruption, where orders that “hide and light” are permitted to queue jump orders commonly used by institutional investors, see “For Superfast Stock Traders, a Way to Jump Ahead in Line.”)
To appreciate the significance of DAY ISO queue jumping, it is key to understand that among all the special order types, only the DAY ISO can light a new aggressive price on an exchange that locks an away market. In practice, this lighting capability provides an alternative end-around to Rule 610 and the ban on locked markets and provides HFTs a backdoor to the top of the queue.