Trading Skills & Essentials

Cross Trade

What Is a Cross Trade?

A cross trade is a practice where buy and sell orders for the same asset are offset without recording the trade on the exchange. It is an activity that is not permitted on most major exchanges.

A cross trade also occurs legitimately when a broker executes matched buy and a sell orders for the same security across different client accounts and reports them on an exchange. For example, if one client wants to sell and another wants to buy, the broker could match those two orders without sending the orders to the stock exchange to be filled but filling them as a cross trade and then reporting the transactions after the fact but in a timely manner and time-stamped with the time and price of the cross. These types of cross trades must also be executed at a price that corresponds to the prevailing market price at the time.

Cross trades are often performed for trades that involve matched buy and sell orders that are linked to a derivatives trade, such as the hedge on a delta-neutral options trade.

How a Cross Trade Works

Cross trades have inherent pitfalls due to the lack of proper reporting involved. When the trade doesn't get recorded through the exchange one or both clients may not get the current market price that is available to other (non-cross trade) market participants. Since the orders are never listed publicly, the investors may not be made aware as to whether a better price may have been available. Cross trades are typically not allowed on major exchanges. Orders need to be sent to the exchange and all trades must be recorded.

However, cross trades are permitted in select situations, such as when both the buyer and the seller are clients of the same asset manager and the price of the cross trade is considered to be competitive at the time of the trade.

A portfolio manager can effectively move one client's asset to another client that wants it and eliminate the spread on the trade. The broker and manager must prove a fair market price for the transaction and record the trade as a cross for proper regulatory classification. The asset manager must be able to prove to the Securities and Exchange Commission (SEC) that the trade was beneficial to both parties.

Key Takeaways

  • A cross trade is a practice where buy and sell orders for the same asset are offset without recording the trade on the exchange. This is an activity that is not permitted on most major exchanges.
  • A cross trade also occurs legitimately when a broker executes matched buy and a sell orders for the same security across different client accounts and reports them on an exchange.
  • Cross trades are permitted when brokers are transferring clients assets between accounts, for derivatives trade hedges, and certain block orders.

Concerns About Cross Trades

While a cross trade does not require each investor to specify a price for the transaction to proceed, matching orders occur when a broker receives a buy and sell order from two different investors both listing the same price. Depending on local regulations, trades of this nature may be allowed, since each investor has expressed an interest in completing a transaction at the specified price point. This may be more relevant for investors trading highly volatile securities where the value may shift dramatically in a short period of time.

Cross trades are controversial because they may undermine trust in the market. While some cross trades are technically legal, other market participants were not given the opportunity to interact with those orders. Market participants may have wanted to interact with one of those orders, but was not given the chance because the trade occurred off the exchange. Another concern is that a series of cross trades can be used to 'paint the tape,' a form of illegal market manipulation whereby market players attempt to influence the price of a security by buying and selling it among themselves to create the appearance of substantial trading activity.

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