Block Trade

Block Trade Definition

Block Trade are securities that are bought and traded by an investor in bulk quantities and such trade involves negotiations of very huge number of equity and bonds which are traded among two parties, usually with the help of an investment banker, at an appropriately arranged price and outside of the stock market so as to reduce the effect on the price of the security.

Block trade involves trading in the notably high number of bonds and equity by two parties at a price appropriately arranged. Many times investors prefer to make such trades to save from the cut in the prices because, in that case, the price may be mutually decided favorably to the seller. Generally, it involves the minimum quantity of 10,000 numbers of securities, which excludes penny stocksPenny StocksPenny stock refers to stocks that trade at a low price, typically less than $5 per share and are highly illiquid. Usually, these stocks belong to small and newbie companies with a low market capitalization.read more or bonds worth $200,000. In the practical world, block trading involves much more than 10,000 shares.

Block Trade

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How Block Trade Works?

Let’s take an example of a hedge fundHedge FundA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques.read more that wants to sell 200,000 shares of a small company having $20 as the current market price. It is the transaction involving the 4 million dollars on the company that might worth in total only some hundred million. Now, if the same is entered as the single market order, then it probably would lead to the push down of the prices. Also, being the size of the transaction is high, and the existence of the market making, the order will be executed at the progressively worse prices. Due to this, slippage on order would be observed by the hedge, and on the same, piling on the short would be done by other participants in the market based on price action. It would force stock down further.

So, to avoid the same, hedge funds generally take the help of the blockhouse where the blockhouse helps in breaking up a large amount of trade into some manageable one. Like for instance, in the present case, the 100 smaller blocks can be made with 2,000 shares each at the price of $20 per share. Now to keep the overall market volatility low, each of the divided blocks will be initiated by the separate broker. Also, instead of the above option, any broker can make an arrangement with any buyer who can take all the 200,000 shares outside the open market by means of the purchase agreement. Generally, in this case, the buyer is some another institutional investor as the amount of capital involved in these type of transaction are high.

Advantages

  • It is one of the useful means by which the analysts can assess where institutional investors do the stock pricing.
  • It is helpful in case of the merger or acquisitions as in that case bid require to “clear market,” so for that, the prices at which the large block of stocks are trading can be seen. These prices show that at what rate the largest shareholders of the company are ready to sell their owned shares, and thus, in the case of the block trading analysis, mostly the small trades are considered in order to avoid the data skewing.

Disadvantages

  • The Block trade is more difficult than the other type of trades because the broker-dealer is committing to a price. For a large amount of the securities, so, in case there is any adverse movement in the market, then it can saddle the broker-dealer with a huge amount of loss (in case the position is being held and not been sold). So engaging in the activity of block trading can lead to tie-up of the capital of the broker-dealer. Thus due to this, broker-dealer are often exposed to more risk.
  • There are situations where the well informed large money managers want to buy or sell the large stock position of the particular stock, which may connote the price movements in the future by performing the opposite of the transaction of the broker-dealer. By this, the money managers have an informal advantage, and the broker-dealer will have an adverse selection risk.

Important Points

Conclusion

Block Trades are the large trades that are made by the institutional investors, which are broken generally into the smaller orders first and then executed through the means of the different brokers in order to mask true sizes. These are trades that can be done outside the open market and through a private purchase agreement. It can prove to be more difficult than the other trade and may expose the broker-dealer to more risk. It is useful for analysts to assess where institutional investors do stock pricing.

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This article has been a Guide to Block Trade and its definition. Here we discuss how the block trade works along with example advantages and disadvantages. You can learn more about financing from the following articles –

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