What are Block Trades?

Introduction

A massive, privately-negotiated exchange of securities is known as a block deal. The purpose of arranging block trades outside of public markets is to reduce the impact on the price of the security. Hedge funds and other institutional investors often conduct them through investment banks and other middlemen, but, accredited high-net-worth individuals may also be able to take part.

All it takes is one block trade for a huge number of shares to be changed hands. Usually, many buyers are paired with one big supplier. Hedge funds, private equity firms, pension funds, and ultra-wealthy individuals often use investment banks and brokers to execute these types of trades.

What are Block Trades

The impact on the share price of a large-sized sell order put on a stock market can be substantial. On the other hand, other market participants won't know about the extra supply until the transaction is publicly disclosed, even though a privately negotiated block deal will typically offer a discount to the buyer.

Disclosure of block trades that have not yet been made public is forbidden by the financial industry's self-regulatory body, FINRA, due to the fact that it is deemed material non-public information.

Expert intermediaries that can help with block trades include block trading facilities and block houses. Block houses are divisions inside brokerages that run dark pools, which are private exchanges that match big buy and sell orders incognito. For the purpose of hiding the extent of extra supply, block houses can divide up big deals on public markets, for instance by placing multiple iceberg orders.

Block trades typically occur outside of regular market trading hours and are launched, completed, and priced very rapidly. If the market closes around 16:30, the outcomes of the block deal, including the price, are published early the next morning before the market opens. A "launch announcement" is then released. Any trade for more than $200,000 or involving more than 10,000 shares of stock is considered a block trade by the New York Stock Exchange and the Nasdaq. Typically, block trades go well above these thresholds.

A large-scale, privately-negotiated securities transaction is the simplest way to describe it. To hide their actual size, block trades are often divided into smaller orders and conducted through many brokers. A private purchase agreement allows for block trades to take place away from the public market.

Understanding Block Trades and how it works

Block trades are so large that individual investors almost never participate in them. Typically, big funds or trading desks may use Wall Street investment banks or other intermediaries to purchase and sell huge quantities of shares or bonds, leading to block trades.

Market participants must exercise extreme caution while engaging in block trades on open market exchanges, as these large-scale transactions have the potential to significantly affect trading volumes and bond prices. Because of this, fund or trading desks rarely purchase and sell securities in bulk on the exchange; instead, they often employ an intermediary.

A middleman, or "block house," is usually involved in a block trade. Companies like these focus only on trading huge blocks of securities. Their expertise allows them to cautiously make massive block trades, which helps them to often avoid causing volatility and a significant increase or decrease in the security's price. When it comes to managing and executing massive trades, block houses employ traders with a wealth of knowledge. They are able to trade these massive blocks of securities without influencing prices because of their specific relationships with other block houses, brokers, and trading desks.

The block house is usually the first point of contact for funds and other large traders when they are ready to execute a block trade, with the expectation that they can negotiate the best terms for the trade. Traders and brokers that focus on the security being purchased or sold are contacted by the block house staff after the order has been placed. Smaller blocks of buyers or sellers will usually fill the order. Special orders, also known as iceberg orders, are also involved, and they conceal the true magnitude of the order.

Advantages of Block Trades

A dramatic shift in the supply and demand for a stock, as a consequence of a massive buyout or selloff, can cause price fluctuations. For the sake of market price stability, it is prudent for a fund manager to arrange a large-scale stock acquisition or sale in a manner that mitigates the negative impact of the massive supply-and-demand mismatch.

The fund manager always sets an ideal average price objective for large-scale stock purchases. If you want to keep the price close to your target average, you need to avoid making it excessively volatile. A fund manager can make the necessary transactions with less effect on price volatility and better average price via block trades via block houses.

Expenses associated with execution are also crucial. Placing many smaller transactions in an effort to fulfil a single large purchase or sell order may increase costs and might potentially lead to the same negative impact on price volatility. This effect can be mitigated with the help of block trading.

How Block Trades Impact Individual Investors

Without vital information supplied by block trades, institutional investors would not go to such extreme measures to conceal their block trading. The short-term future movement and liquidity of a securities can be inferred from a block deal. On the other hand, it can signal a change in market mood.

Understanding the significance of a block transaction can be challenging for individual investors as well. A massive transaction that appears to be a turning point for a popular stock can actually be a small tweak made by a massive mutual fund.

Retail investors can, however, discover details regarding block trades. Many internet resources exist that serve as block trade indicators; some of these resources are provided by popular online brokerages. For online stock trading, this might be helpful.

A large number of these instruments make use of Level 2 data from the Nasdaq Quotation Dissemination Service (NQDS). The NASDAQ order book is made available to investors through this subscription service in real time. Market makers registered to trade every security on the NASDAQ and OTC Bulletin Board provide price quotes in its data stream, which is popular among investors who trade based on market depth and momentum.

Finding block trades will still be challenging, even with access to such technologies. For example, some blockhouses adopt tactics like "iceberg orders" to evade detection on Level 2. The consolidated tape records all deals through blockhouses and dark pools, but investors have a better chance of catching a glimpse of these big trades when software filters are used in conjunction with it. However, this tape is typically created long after the trades have been fully executed.

The level of seriousness with which you trade will determine whether or not you should invest in these software tools, which range substantially in price and complexity. One technique to monitor the buying and selling activity of big institutional investors and fund managers is to use software that scans for block trades. The data might help active traders identify emerging patterns.

Different types of Block Trades

A block trade can be structured in three different ways:

Non-risk deal: Known as an expedited equity offering. Before setting a price, the investment bank managing the block trade gauges’ buyer interest. The seller normally pays the manager a commission or spread.

Bought deal: A purchased or bought deal occurs when the investment bank arranging the block trade buys the shares from the seller before marketing. The manager quickly resells the shares, keeping the difference between the buy and sale prices. This gives managers the chance to profit but also demands risk.

Back-stopped deal: This contract includes bought and non-risk factors. Instead of buying the shares, the manager guarantees the seller a minimum price before marketing. If the manager cannot sell all shares at or above the minimum (‘back-stopped’) price, it buys them.

Example of a Block Trade

Assume a hedge fund manager must sell 1 million Tesla shares. Tesla averages 4 million shares every day. Since it would represent 25% of TSLA share volume, selling all the shares at once would likely cause a dramatic price decline. Market orders, limit orders, and iceberg orders won't work here.

Instead, the hedge fund manager requests a trusted block house to conduct the deal. The block house may know a buyer or several buyers for Tesla shares since it knows other significant buyers and sellers. The block house might negotiate a price that works for both sides and execute the deal off the exchange, avoiding any impact on TSLA's market price.

The dark pool is another option if the block house cannot find a buyer for the shares off the exchange. The block house can publish this enormous block of shares and engage with opposing purchase orders in dark pools because they just show an order, not how many shares are in it. This may handle all the shares, or the block house could divide up the order and send it to multiple ECNs and brokers at different times and prices to mask the order size and seller.

Imagine selling one million shares of a stock at $120. By splitting the order, the block house sells all the shares at $119.50 each. Due to its fragmentation and distribution over several brokers and ECNs, the order had little impact on that stock's market price.

Are Block Trades Legal?

Block trades are not illegal, but they do have a murky past when it comes to the stock market. The regulations of the New York Stock Exchange define "blocks" as previously stated. However, no official definition has been released by regulators such as the SEC.

In addition, block trades are not manipulative even if they have the potential to impact markets. They're basically a way for big investors to change their asset allocation strategy with minimal impact on the market and stock volatility.

Pros and Cons of Block Trades

Conclusion

Block trades, which are massive position changes by institutional investors, can be hard for ordinary traders to spot. However, there are perks for individual investors in these trades. Shareholders of the mutual funds and exchange-traded funds (ETFs) held by the majority of investors in brokerage accounts, IRAs, 401(k)s, and 529 plans stand to gain from the reduced trading costs and reduced volatility brought about by block trades.