Trading and Exchanges Chapter 24: NYSE Specialists and Designated Market Makers
The New York Stock Exchange used to have these people called specialists. Each one was assigned a handful of stocks and was basically the boss of all trading in those stocks. They stood at a physical post on the floor, saw every order coming in, ran the opening auction, and traded with their own money when nobody else would. One of the most privileged positions in finance. And one of the most controversial.
What Specialists Actually Did
A specialist wore three hats. Dealer: traded with own money. Broker: held and executed orders that other brokers left with them. Exchange official: ran the auction process and kept trading orderly. Three roles, one person. You can already smell the conflict of interest.
At the NYSE, about 482 individual specialists covered all listed stocks. Most handled three to six stocks each. By 2001, only eight firms employed all NYSE specialists, and five of them handled 95% of dollar volume.
Obligations: The Price of the Seat
Specialists had two types of obligations. Affirmative obligations forced them to provide liquidity when nobody else would. They had to quote two-sided markets (both a bid and an ask) at reasonable spreads. They were the traders of last resort.
They also had to maintain price continuity. If a gap in the order book would cause a wild price jump, the specialist stepped in to smooth it. Buy when everyone is selling. Sell when everyone is buying. Painful.
Negative obligations restricted what they could do. The public order precedence rule said specialists could not trade at a given price until all public orders at that price were filled. They also should not trade with limit orders sitting in their book. Basically, do not steal trades from regular people.
In tight markets where the spread was just one tick, specialists could barely trade at all. They could only buy at the ask or sell at the bid, which is backwards from how you make money.
The Privileges That Made It Worth It
So why would anyone accept these obligations? Because the privileges were fantastic.
Information advantage. Specialists saw the entire order flow. Every system order, every limit order book entry, every floor broker standing in front of them. They knew who wanted to buy, sell, and how much. Like playing poker while seeing everyone’s cards.
The opening auction. The specialist ran the opening. They saw all pre-market orders and chose the clearing price after everyone else had committed. Harris gives an example where a specialist wanting to sell 16 lots strategically sells only 15 to avoid depressing the price. The option to decide last is extremely valuable.
Cream skimming. When a market order came in, the specialist could look at where it came from before acting. Small retail order from an uninformed trader? Step in front of the book, give a slightly better price, take the profitable trade. Large institutional order that might be informed? Let the limit order book handle it. Cherry-pick the easy orders, leave the dangerous ones for everyone else.
Stopping stock. Specialists could “stop” an incoming order, guaranteeing a minimum price while waiting to see what happens. If prices moved favorably, exercise. If not, wait for someone else to take it off their hands. Free optionality.
The SPDR Story
Harris shares a wild anecdote. Around 1998-1999, the SPDR (S&P 500 ETF) specialist received a stop order to sell 500,000 shares at 100 when the SPDR was at 100.50. He aggressively shorted S&P 500 futures in Chicago to push the market down and trigger the stop. Nearly pulled it off, but a market maker bid just above 100, price bounced, and the specialist got stuck with a losing short. He was manipulating the futures market to exploit his own client’s order. This is the kind of thing that gave the system its reputation.
Why It Was Controversial
The specialist system created a wealth transfer. Small market order traders benefited from price improvement. But limit order traders got hurt because specialists kept stepping in front of their orders, taking profitable trades, leaving them with leftovers. The people who benefited and the people who paid were not the same group. And the people who paid often did not understand what was happening.
There was also a free rider problem. Specialists provided price continuity, which is a public good. Everyone benefited, including traders at other exchanges who never paid for it. When markets were calm, other dealers competed with specialists for profits. When volatility spiked and everyone ran away, the specialist was the only one left, losing money to fulfill obligations.
Many argued the problems were unsolvable. Specialists had too much power, too much information, too many ways to extract value. The solution that won was electronic trading and multiple designated market makers.
The Origin Story
Folklore says in 1875, a man named Boyd broke his leg on the NYSE floor. Unable to walk around, he sat in a chair and traded only Western Union. Brokers appreciated always knowing where to find him, left their orders with him. First specialist born from a broken leg and good customer service.
The real lesson: concentrating information and trading power in one person creates better markets in some ways and worse in others. Whether privileges outweighed obligations was never settled by theory. Electronic markets made the whole structure obsolete.
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