free floating tankers
Supply/demand dynamics play an important role in the determination of stock prices. That is why you can not simply go ahead and buy a large stake in a public company at its prevailing market capitalization. The price reflects the beliefs of the current market participants and your entrance will change the dynamics of the game.
For instance, the way you enter the market will make a significant difference. There are two important points to consider here:
1) It is usually not a good idea to reveal your identity early on. If the market thinks you are more informed about the value of the stock than they are, then they will be more hesitant to sell at the prevailing prices.
2) Large orders suck liquidity out of the market and cause big ripples in prices. (Price may shoot up even before the execution of the large order due to information spillover and front-running.)
Therefore it is usually a good idea to hide your intention of acquiring the company by executing small orders through various different intermediaries. (Note that there are existing laws that will force you to reveal your position after gathering X percentage of the available shares.)
Is there an exact definition of what constitutes a "large" order? No. There are two importanat parameters here.
1) First is the percentage of shares that is free floating. For example, some shares are held by institutions on a long term basis and are not available for spot trading. Unless those institutions are willing to engage in a block trade with you, the only shares you can demand are those that are free floating (i.e. changing hands in the spot market). Let's assume that you want to buy 1% of the total number of outstanding shares. In other words, if the total number is 1000, your order will be for 10 shares. Now assume that the percentage of free floating shares is only 20. Although your order looks small compared to the total number shares, it demands 5% of the number of shares that are available.
2) Will that 5% move the market price? That depends on how much liquidity you will be sucking out of the market. If trading volumes are low and bid/ask spreads are high, then you are more likely to cause a ripple.
The concept of free floating is relevant to commodity markets as well. Let's consider an example. What will happen to tanker freight charges if the world seaborne crude oil trade slows down 1% in terms of tonnage? For the sake of simplicity we can disregard the size segregation in the tanker market. Moreover, since it is pretty easy to move ships across continents, we can assume that the geographical effect of the slowdown will be arbitraged away and the freight rates will go down globally.
Here the important parameter is the percentage of ships on the spot market which is the arena where freight rates get determined. Each big oil company has its own tanker fleet which is usually supplemented by some ships on long-term time charter. If these ships are all occupied (or if none of them are available around the port where the cargo needs to be picked up from), then the company will hire a tanker in the spot market. And when the company needs less ships, it will pay less visits to the spot market.
This is where an analogy with stock markets can help us. One can think of the freight charge as the stock price and the percentage of ships on spot market as the percentage of shares floating. As pointed out in the analysis above, 1% contraction in the global demand can have the effect of 5% contraction on freight charges if percentage of ships on spot market is 20.
For instance, the way you enter the market will make a significant difference. There are two important points to consider here:
1) It is usually not a good idea to reveal your identity early on. If the market thinks you are more informed about the value of the stock than they are, then they will be more hesitant to sell at the prevailing prices.
2) Large orders suck liquidity out of the market and cause big ripples in prices. (Price may shoot up even before the execution of the large order due to information spillover and front-running.)
Therefore it is usually a good idea to hide your intention of acquiring the company by executing small orders through various different intermediaries. (Note that there are existing laws that will force you to reveal your position after gathering X percentage of the available shares.)
Is there an exact definition of what constitutes a "large" order? No. There are two importanat parameters here.
1) First is the percentage of shares that is free floating. For example, some shares are held by institutions on a long term basis and are not available for spot trading. Unless those institutions are willing to engage in a block trade with you, the only shares you can demand are those that are free floating (i.e. changing hands in the spot market). Let's assume that you want to buy 1% of the total number of outstanding shares. In other words, if the total number is 1000, your order will be for 10 shares. Now assume that the percentage of free floating shares is only 20. Although your order looks small compared to the total number shares, it demands 5% of the number of shares that are available.
2) Will that 5% move the market price? That depends on how much liquidity you will be sucking out of the market. If trading volumes are low and bid/ask spreads are high, then you are more likely to cause a ripple.
The concept of free floating is relevant to commodity markets as well. Let's consider an example. What will happen to tanker freight charges if the world seaborne crude oil trade slows down 1% in terms of tonnage? For the sake of simplicity we can disregard the size segregation in the tanker market. Moreover, since it is pretty easy to move ships across continents, we can assume that the geographical effect of the slowdown will be arbitraged away and the freight rates will go down globally.
Here the important parameter is the percentage of ships on the spot market which is the arena where freight rates get determined. Each big oil company has its own tanker fleet which is usually supplemented by some ships on long-term time charter. If these ships are all occupied (or if none of them are available around the port where the cargo needs to be picked up from), then the company will hire a tanker in the spot market. And when the company needs less ships, it will pay less visits to the spot market.
This is where an analogy with stock markets can help us. One can think of the freight charge as the stock price and the percentage of ships on spot market as the percentage of shares floating. As pointed out in the analysis above, 1% contraction in the global demand can have the effect of 5% contraction on freight charges if percentage of ships on spot market is 20.
