The term duty of best execution refers to the legal responsibility of a broker to provide the most favorable terms when executing an order on behalf of an investor. Factors a broker should consider under their duty of best execution include price, speed, and likelihood of execution.
Explanation
The duty of best execution is a requirement under the jurisdiction of the Securities and Exchange Commission (SEC). This requirement mandates a broker to seek out the most favorable terms of execution reasonably available to their clients. These terms include securing the best possible price, executing the order as quickly as possible, and evaluating the likelihood an order will be filled. This is accomplished by assessing opportunities in competing markets, and understanding if the order would secure more favorable terms by routing it to a market maker or an electronic communications network.
The SEC monitors compliance with the duty of best execution through a series of reports. Brokers are required to provide quarterly data indicating the routing of their clients' orders as well as monthly reports that reveal the quality of execution such as payment flow.
The term execution refers to a transaction that completes buy or sell orders for a security or futures contract. The execution of an order is typically facilitated by a third party, such as a broker.
The term ex-pit transaction refers to a commodity transaction that takes place away from the floor of the exchange where it would normally occur. Ex-pit transactions typically involve the cash market and a private deal between two hedgers.
The term exercise refers to the right granted in an options contract which allows the holder to buy or sell the underlying asset. American options allow the holder to exercise this right any time before the contract expires.
The term price improvement refers to the process of obtaining a lower than offer price when buying a security or a higher than bid price when selling a security. Price improvement is one of the possible outcomes from a broker's duty of best execution.
The term payment for order flow refers to the compensation received by brokers from third parties when an order is routed to the third party for execution. Payment for order flow is one of several ways a broker is compensated when an investor places a buy or sell order.
The term assigned refers to the process whereby the writer, or seller, of an option is asked to fulfill their obligation under their contract. When assigned, an option writer has the obligation to either sell or buy the underlying asset at the agreed to price.