Alternate Display Facility (ADF) orders explained

What is Alternative Display Facility (ADF)?

This Optional Display Facility (ADF) Part of the market infrastructure managed by FINRA. Institutions use it to post quotes and report trades.

It is called Optional Display facility as ADF is an exchange option for organizations to post quotes and report trades.

It’s basically where organizations can post quotes and report trades that don’t happen on regular exchanges. These off-exchange venues can be dark pools, insider trades (where your broker or an affiliate trades against you, ie, paying for order flow trades) or even directly negotiated trades, where two parties meet over the phone and arranges. Trade away from the exchange.

Of course, when these trades take place, they still have to be reported to the consolidated tape (time and sales). However, since it did not occur on an exchange that automatically reports the trades, they must be reported to a separate venue.

These deals do not have to comply with the National Best Bid and Offer (NBBO) rule of the SEC’s Regulation NMS, meaning deals reported to ADF can vary dramatically from the current best bid and offer.

This is where ADF comes in. It enables such trade reporting.

Remember that, unlike Exchange, there is no hand in implementing ADF. It is a display-only facility where organizations can post quotes and report their trades. Any trades reported from ADF were actually executed elsewhere.

But ADF is not the only game in town. In fact, they are a very minor player in the off-exchange trade reporting game.

Alternate Display Facility (ADF) Vs. Trade Reporting Facility (TRF)

There are two primary parts of the off-exchange trade reporting infrastructure: the Trade Reporting Facility (TRF) and the Alternative Display Facility (ADF).

The difference is that the TRF is run by the exchanges, while FINRA runs the ADF.

TRF is where 99.999% of off-exchange trades are recorded. These are deals on dark pools, negotiated deals, insider trading etc. Any over-the-counter trades, aka, not taking place on a lit exchange, are reported to the TRF.

By now, TRF is the more prominent player, which makes it so that ADF is very insignificant in the stock market.

in fact, According to FINRA, the operator of ADF, currently has zero quoting broker-dealers on ADF. However, there is only one broker, JP Morgan, that uses ADF for trade reporting.

ADF is not considered to be a competitor to TRF. It was founded in 2002 for a specific, old concern; For ECNs who did not want to post their quotes on NASDAQ’s books because they believed that NASDAQ’s algorithms favored NASDAQ market makers rather than ECNs.

Regulation NMS essentially made the ADF obsolete and has been rarely used since the establishment of Reg NMS in 2005.

Whale watching on ADF

Since ADF is used and used exclusively by JP Morgan for trade reporting, it is confusing why we would devote any time to this topic.

Let’s flashback to April 18, 2022, in the midst of a cold bear market in SPACs, there was a massive liquidation of SPAC warrants in extended-hours trading. SPAC warrants are essentially company-issued foreign call options on SPACs that are offered as a sweetener to SPAC investors.

Like any call option, a SPAC warrant has a calculable intrinsic value. If you can buy these warrants below their intrinsic value, it’s like free money, although SPAC warrants typically can’t be exercised until the deal is announced.

Regardless, many traders adopted this structure of playing arbitrage of mispriced SPAC warrants.

That’s why many of them turned a blind eye to their montage that April evening when huge block trades, like a block of nearly 300,000 warrants for SPAC McLaren Technology Acquisition Corp (MLAIW), went for just a penny, along with several other SPACs. Warrant block trades are taking place at ridiculous prices.

And all these deals were printed on ADF, which is very strange.

You can never tell the story behind a trade; That is the nature of the US stock market structure. But it is widely believed that hedge funds needed to quickly liquidate portfolios of SPAC assets and negotiate over-the-counter trades with other hedge funds.

Many traders were also stunned. They bought orders for these warrants at better than reported prices but were never filled, so what happened? These traders’ bids sit on the order books of stock exchanges such as the NYSE. But this trade was negotiated and never touched the exchange, so never triggered any buy orders. And because these deals don’t need to comply with the NBBO, they’re perfectly legal.

From these block trades, an astute trader can make some insights; That at least one large fund heavily involved in SPACs has liquidity problems and could lead to more fire-sales, which would certainly be depressing for the SPAC market.

But you can make similar insights from the deals reported on TRF. So again, why the emphasis on ADF?

Because JP Morgan is the only reporting participant on ADF.

It’s not exactly clear why ADF was used to report these trades, but on the rare occasions when ADF is used, the trade is overweight for whatever reason.

So you can just look at reported volumes and if a lot of trades are being reported to ADF, you know that JP Morgan is actively trading the security. And for some reason if they are reporting on ADF, the catalyst can come.

Bottom line

This market structure can be tedious, and the information released there is so technical in nature, that it is difficult to understand in practical terms.

For this reason, few traders take the time to discover, understand and implement strategies based on this content. It’s nowhere near as exciting as studying the latest chart patterns or technical indicators. And that’s precisely why it can be so rewarding.

Having said that, ADF is rarely used these days, with JP Morgan being the only participant, so you can’t expect it to create a consistent trading strategy, but on the rare occasion that you spot an opportunity, it will pay off with a little study.

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