The Half-Penny Revolution: Will SEC's Reform Benefit Investors?

Key Points

• The SEC's sub-penny tick size reform aims to reduce investor trading costs.
• Market makers are concerned about potential liquidity issues and increased volatility.
• The reform is expected to significantly impact stocks with narrow bid-ask spreads, low prices, and high trading volume.

The US Securities and Exchange Commission (SEC) has embarked on a significant overhaul of the US equity market structure, with a key component being reducing the minimum tick size from one penny to half a penny. This move, expected to take effect in November 2025, promises to reshape the way stocks are priced and traded, potentially impacting investors' bottom line. While the SEC anticipates the change will usher in a new era of efficiency and lower trading costs, industry experts are divided on the full scope of its impact.

The tick size represents the minimum price increment at which a stock can be bought or sold. In the current system, the tick size is one penny, meaning that a stock priced at $10.00 can only be bought or sold in increments of one penny. This constraint creates a potential barrier to efficient pricing, particularly for relatively inexpensive stocks like penny stocks, whose bid-ask spreads are narrower than a penny.

The Evolution of Tick Size: A Historical Perspective

The US stock market has experienced a gradual transition in tick size throughout its history. Originally, stocks were priced in fractions of a dollar, such as one-eighth of a dollar. In 2000, the market transitioned to decimal-based pricing, which ushered in a reduction in the tick size to one penny. This shift to decimalization was intended to create a more transparent and efficient trading environment. However, the market dynamics have evolved over the years, and the current tick size has become outdated.

The Half-Penny Revolution: Narrowing the Spread

The SEC's decision to allow stock markets to price shares in increments of half a penny is designed to address this issue. The smaller tick size will effectively narrow the bid-ask spread, the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. This spread narrowing is expected to directly benefit investors by lowering transaction costs. In essence, investors will pay less to buy and sell shares, translating into greater profitability for their trading activities.

The SEC's rationale for this change is rooted in the belief that the current 1¢ tick size is outdated and inhibits market efficiency. SEC officials say around 74% of share volume is quoted at under 1.5 pennies. This means stocks with a bid-ask spread of around 1 cent have no room to fall further. This lack of flexibility in pricing can make it challenging for investors to find the best possible prices and can lead to unnecessary transaction costs.

Who Stands to Gain (or Lose)? 

While the SEC's sub-penny tick size reform is poised to affect the broader stock market, certain sectors and types of stocks are likely to experience more significant shifts. The impact will largely hinge on a stock's existing bid-ask spread, trading volume, and price range.

Stocks with narrow bid-ask spreads, often characterized by high liquidity and active trading, will likely see the most pronounced changes. The narrower tick size will enable more precise pricing, potentially lowering investor transaction costs. This could stimulate greater trading activity, making markets more efficient for these securities.

Low-priced stocks, particularly those trading below $1 per share, are also likely to feel the effects of the reform. These stocks tend to have limited trading volume and wider bid-ask spreads, hindering investor participation. The smaller tick size has the potential to narrow these spreads, making low-priced stocks more attractive to investors and boosting their market liquidity.

Stocks with high trading volume, often found in large-cap companies or popular sectors, are also likely to experience greater impact. The increased trading volume provides more opportunities to leverage the smaller tick size, leading to more efficient price discovery and potentially lower costs for investors.

However, stocks with limited trading volume might see less significant changes. These stocks already have wider bid-ask spreads, and the smaller tick size might not have a substantial impact. However, the rule change could still indirectly influence these stocks by increasing overall market efficiency.

Sectors known for high growth potential, such as technology, biotech, and clean energy, could be more significantly impacted. These sectors often experience rapid price fluctuations, making them more sensitive to changes in tick size and price increments. The narrower tick size could improve price efficiency and potentially reduce volatility in these high-growth sectors.

Conversely, stocks with wide bid-ask spreads, typically those with lower liquidity and limited trading activity, may see less significant changes. The existing spread is already wide enough that the smaller increment might not have a substantial impact. Similarly, high-priced stocks, often those with higher valuations and greater investor interest, may see less of an impact. Their trading volume is generally sufficient to make the 1-cent increment a less significant factor in their pricing.

While the SEC's sub-penny tick size reform promises to create a more efficient market, it is essential to monitor how the rule change affects specific stocks and sectors within your portfolio. The impact will be influenced by a variety of factors, including individual stock characteristics, market conditions, and the response of market participants.

Implementation Timeline: A Look Ahead

The new tick size rule is expected to take effect in November 2025, giving market participants ample time to adjust to the changes. This extended implementation timeframe is intended to minimize disruption and allow for a smooth transition. The SEC is also committed to closely monitoring the impact of the rule change and making any necessary adjustments to ensure that the reforms are successful in achieving their intended goals.

The Half-Penny Revolution: A New Era for Investors?

The SEC's sub-penny tick size reform is a significant step towards a more efficient and cost-effective US equity market. While the full impact of the rule change remains to be seen, the potential benefits for investors are significant. Reduced transaction costs, enhanced market liquidity, and greater price transparency could ultimately lead to better returns for investors. However, it is crucial to remain vigilant and closely monitor the implementation and impact of this reform. Only time will tell whether the half-penny revolution will be a resounding success for investors or a missed opportunity.