A crossed market refers to a temporary situation where bid prices associated with a particular asset or security is higher than the asking price. Also referred to as backwardation, it is the futures market relationship where the prices are lower than the spot prices.
A crossed market is a temporary situation that presents an arbitrage opportunity.
It is where the situation can result in a quick profit for the arbitrageur. This type of market is considered to be contrary to normal situations where the asking price is higher than the bid price.
A crossed market develops as a result of anticipated events which occur during the trading day for example a high influx of orders.
This results in the market developing an extremely high amount of orders which are entered before the official opening of the market but can also happening during open market hours.
During market hours, bids can be higher than an ask, creating a crossed market, but more often than not, it is just a stale quote that hasn’t been removed by the market makers.
An imbalance between the bid-ask spread occurs but the good news is that the gap between ask and bid price will shrink by the time the market is opened unless a factor or phenomenon in the economy continues feeding this situation.
Origin of Crossed Market
There are three factors that led to the origin of crossed market and they include:
a. Switching from quoting security prices in fractions of a dollar to quoting in cents
This switch happened between March and April 2001 leading to effective bid-ask spreads. The average spreads on the securities decreased on a volume weighted based. This was also followed by decimalization which increased the quotes updates.
b. Launch of Supermontage
In mid October 2002, NASDAQ launched a new trading platform which was supposed to help in centralizing liquidity on listings. Market makers were given the chance of participating by posting quotes on a non linked market center.
This resulted in market participants posting quotes on regional exchanges and operating independently. Before Supermontage was launched, crossed market rarely occurred. This is because market participants obliged to execute all posted quotes before they were crossed.
c. Differential access fees and liquidity rebates
A time came when market participants opted out of using the Supermontage. This resulted in fierce competition between rival markets and NASDAQ. Liquidity rebates were offered to traders and larger liquidity providers gained higher rebates and paid lower access fees.
Crossed Market Example
If a market maker were to enter a bid of 12.15 or make an offer of 16.25, the bid or offer will have crossed the market. When this happens, the market maker is supposed to make an effort to trade will all market makers with a bid or offer that would cross or lock.
A crossed market is a temporary situation which corrects itself before the market opens or shortly after it occurs.
The chances of the situation extending is dependent on upheavals in the wider economy especially a direct impact on specific securities.