The technical procedures set up for price creation purposes reduce the possibility of this being driven by the entry of a single exceptional, or even incorrect, order. Conceptually the opening auction to a large extent corresponds to the old “call market”, although implemented by way of electronic means. The flow of orders relating to each security are recorded and are not executed immediately; once the time for submitting orders has elapsed, Borsa Italiana’s electronic system, like a modern electronic auctioneer, identifies the price at which all compatible orders are concluded. This should guarantee an opening price that reflects the entire supply and demand present on the market by a set time.
The auction has three phases:
- Pre-auction or pre-opening;
- Validation;
- Actual opening.
The pre-auction takes place from 8:00:00 to 9:00:59, for securities in the Blue Chip and Star segments. During this time the system allows entry, modification and cancellation of orders. The software sorts the orders in real time according to price – in decreasing order for bids, increasing order for asks – and timing, then calculates and continuously updates the theoretical opening price, based on the orders present. The intermediaries have full visibility of the “book”, i.e. the list of all orders.
The theoretical opening price corresponds to:
1. The price at which the largest quantity of the security is tradable;
2. The price at which there is least difference between the volume of bids and offers, namely the price which leaves the smallest quantity unexecuted, with the same volume traded;
3. The price closest to the previous reference price (i.e. the price of the reference closing auction or, if this cannot be calculated, a price equal to the weighted average of the last 10% of volumes traded) with the same volume and unexecuted;
4. The highest price in the extreme case of other conditions being equal.
We shall now endeavour to explain the concept with some examples.
1) Let us assume that the following orders are present on the market:
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the system will automatically rearrange and combine the orders in the following manner:
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It is clear that whoever is willing to buy at 15.9 will be more than happy to see his order executed at 15.7 (hence in this case 3000 units can be “combined” with the order at 15.7) whereas he will not be willing to pay 16. Anyone entering an order at the “auction price”, on the other hand, will be prepared to pay any price that comes out of the auction (and the relative order will be combined with all the price levels proposed). The ask orders, on the other hand, are obviously combined as the price rises.
In the case of our example, the theoretical opening price is 16 because it is the one which enables the most matching of supply and demand and the largest trading volumes, namely 5000 securities, whereas for example 15.9 would allow only 4000 units to trade.
2) Let us assume, on the other hand, that the orders already sorted and combined are as follows:
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Two prices move the same quantity: 15.9 and 16 enable 5000 shares to trade. However, whilst the price of 16 leaves an unexecuted quantity of 2000, the price of 15.9 produces a supply and demand differential of 3000. The theoretical opening price will therefore be 16.
3) On the other hand, in the case of combined orders as per the following table and a reference price of 15.8:
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the opening price would be 15.9 because with the same quantities traded and unexecuted, it would be the level closest to the reference price.
4) In the case of an assumed reference price of 15.95 and the orders shown in the previous table, the price of both 15.9 and 16 would be equal in terms of order quantity, unexecuted and distance from the reference price. In this situation the higher of the two would be used as auction price, namely 16.
It is not possible to calculate the theoretical opening price in cases where:
- The book is empty;
- There are limited price orders on one side of the market only, i.e. only on the buy or the sell side. In such case the orders proceed to the continuous trading phase with their original price and timing priority;
- There are opening price orders (“OP”) from one side of the market only. These orders proceed to continuous trading and assume the previous day’s reference price;
- There are opening price orders and limited price orders on one side of the market only. In such case, the “OP” orders proceed to continuous trading assuming the best limited price as regards their respective side of the market;
- If the limited prices on the two sides of the market do not allow the conclusion of contracts, i.e. in the event that the highest bid price is less than the lowest ask price. It should be noted that in the opposite situation (best bid price exceeds the lowest ask price) the opening is clearly normal.
Lastly, in cases where only OP orders are present on both sides of the “book”, the system determines a theoretical opening price corresponding to the previous day’s reference price.
The next phase, that of validation, during which the validity of the theoretical price is verified, lasts from 9:01 to 9:05. During this time the system does not accept any new orders and does not allow existing orders to be modified. In order for the price to be considered valid, the difference between the theoretical price and the reference price must not exceed a set percentage which is currently 10% for shares and 5% for convertible bonds.
If the price is not validated, the pre-auction phase is re-opened for a length of time established by the stock exchange.
During the opening phase (9:05 - 9:10): the system proceeds to match compatible orders: contracts are concluded at one price only, the opening price, until the quantities available run out according to the price-timing priorities. Buy orders placed with a limit below the opening price and sell orders with a limit above the opening price proceed to the continuous trading phase.
Let us reconsider the previous example table
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The opening price is 16. All compatible orders will be fulfilled, i.e. trading of the 5000 securities will take place.
Buy orders for 5000 securities at 15.7 and for 3000 at 15.9, and sell orders of 6000 units at 16.1 proceed with their limit to continuous trading. The sell order for 3000 at 16 is executed only for 1000 securities: the remaining portion of the order is transferred with its original limit and priority to continuous trading.
On 18 November 2002, “random” closing of auctions was introduced and extended to all the daily auctions (opening, closing and intraday auctions activated as a result of abnormal volatility) on all equities markets. Following these changes, the possibility to enter orders, and hence to update the theoretical auction price, ends in a moment included within the time span of the last minute of the pre-auction phase, randomly selected by an automatic algorithm. In this way the precise moment of conclusion of the pre-auction phase is not known beforehand and the regularity of the price formation process is enhanced.
The closing auction functions in exactly the same way as the opening auction and its phases are also the same: pre-auction, validation and auction. The only difference concerns the fact that for the Blue Chip, Star and Ordinary 1 segments, the length of time is reduced: the validation and auction phases take place in just 5 minutes. Moreover, if a valid auction price cannot be obtained, no new pre-auction phase is activated.
Any valid orders that are wholly or partially unexecuted are automatically transferred to the following day’s opening auction as orders with price limit (if entered) or as OP (opening price) orders if they had been entered the previous day as closing price orders.
Assuming the presence of the following already sorted and combined orders:
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The resulting valid auction price – as explained above - is 17.
However, only part of the buy orders (4000) are executed, since there is a lack of matching securities. All the other orders are postponed to the next day’s auction: in our example this concerns 2000 unexecuted buy orders limited to 17 or above, buy orders with limit below 16.9 and 3000 sell orders with a price of 17.1.
Lastly, it should be emphasised that the unexecuted orders do not proceed to After Hours trading, since this is a completely separate market from the daytime session.
