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 do 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 exclude penny stocks or bonds worth $200,000. In practical world block trading involves much more than 10,000 shares.
How Block Trade Works?
Let’s take an example of a hedge fund that wants to sell 200,000 shares of a small company having $20 as the current market price. This 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 the 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. This would force stock down further.
So, in order 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 in order 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 the 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.
- This is one of the useful means by which the analysts can assess where the stock pricing is done by the institutional investors.
- 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 case of the block trading analysis mostly the small trades are considered in order to avoid the data skewing.
- The Block trade is more difficult than the other type of trades because the commitment is being made by the broker-dealer to a price and for a large amount of the securities, so, in case there is any adverse movement in the market then it can saddle broker-dealer with the 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 the informal advantage and the broker-dealer will have adverse selection risk.
- The block trade must be done privately such as over private chat, telephone, or other electronic means. It must be transaction through the parties or the brokers directly. So they are executed apart from the public auction market.
- These trades are conducted generally through the intermediaries who are known as the blockhouse. These are the firms that specialize in large trades. These firms are well versed about the block trade and they know how the trade can be initiated carefully so that there is no volatile fall or rise in shares or bonds price.
- As the size of such trades is huge in the case of both equity and the debt markets, the individual investors rarely make any block trades. In the practical world, these trades are done when the institutional investors and the hedge funds buy or sell the large size or amount of shares and bonds in the block trade via intermediaries such as investment banks, etc.
- The traders in the market must be careful while doing the transactions in case the block trade is done on the open market as in that case there will be large fluctuations in the volume of the transaction and the same can cause the impact on the market value of bonds or shares purchased. Thus these trades are conducted generally through the channel of intermediaries, rather than an investment bank or hedge funds purchasing securities normally because then they would do it for smaller amounts.
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 outsider 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 the analysts for assessing where the stock pricing is done by the institutional investors.
This has been a Guide to Block Trade and its definition. Here we discuss how block trade works along with example advantages and disadvantages. You can learn more about financing from the following articles –