NYSE Rule 48 - you don't want to be on the wrong side

Rule 48 was approved at the end of 2007 to allow flexibility for opening and pre-opening indication of stocks that are facing volatile conditions. For market-makers, the rule lets them off the hook at providing pre-open price indications when there is a order imbalance. It has been invoked 77 times since 2008. This is different than a trading halt. When Rule 48 is invoked, the designated market maker can actually open up stocks quicker than normal. Under the normal procedure an exchange official has to approve the opening price. For investor trading can start sooner in a volatile market but that does not mean that you are going to get a "good" price. You are going to get the price that reflect the immediate market conditions that exist at the opening.

The rule:

(a) In the event that extremely high market volatility is likely to have a Floor-wide impact on the ability of [Designated Market Makers] to arrange for the fair and orderly opening, reopening following a market-wide halt of trading at the Exchange, or closing of trading at the Exchange and that absent relief, the operation of the Exchange is likely to be impaired, a qualified Exchange officer may declare an extreme market volatility condition with respect to trading on or through the facilities of the Exchange.

(b) In the event that an extreme market volatility condition is declared with respect to trading on or through the facilities of the Exchange, a qualified Exchange officer shall be empowered to temporarily suspend at the opening of trading or reopening of trading following a market-wide trading halt: (i) the need for prior Floor Official or prior NYSE Floor operations approval to open or reopen a security at the Exchange (Rules 123D(1) and 79A.30); and/or (ii) applicable requirements to make pre-opening indications in a security (Rules 15 and 123D(1)).

To invoke Rule 48, an exchange would have to determine that certain conditions exist that would cause market disruptions. Those conditions include: volatility during the previous day's trading session, trading in foreign markets before the open, substantial activity in the futures market before the open, the volume of pre-opening indications of interest and government announcements.

You can say let the buyer or seller beware because it may be anyone's guess what is the true price. What is clear is that the price is going to change dramatically right after the open either up or down. The price at the end of the day could be unchanged from the previous day. Some study suggest that there is limited abnormal close to close price moves, but this does not account for intraday activity. All we can say is that during Rule 48 conditions all bets are off on what price you will receive. It will be based on the order flow at the time but that flow could place the market under significant pressure.

Market microstructure matters and trading during the initial period of Rule 48 days is a risky proposition as many have found out this August. Hard hit were some ETF which by definition should just be a basket of stocks which have intrinsic value. The deviations from intrinsic value and trade prices tell us that these are not normal times.