Friday, May 14, 2010

Who let the dog out?

A big mystery seller of futures contracts during the market meltdown last week was not a hedge fund or a high frequency trader as many have suspected, but money manager Waddell & Reed Financial Inc, according to a document obtained by Reuters.

Waddell sold on May 6 a large order of e-mini contracts during a 20-minute span in which U.S. equity markets plunged, briefly wiping out nearly $1 trillion in market capital, the internal document from CME Group Inc said.

75,000 ESM0's worth of error comes out to $4 billion. I'd guess that anywhere from 20,000-100,000 contracts trade per hour from 915am - 415pm on most days. To try push 75k minis through a 20 minute window was never going to turn out very well.

There you have it folks. It was caused by an old school, low frequency, no technology, "Toto, we're still in Kansas" shop. Sure, Greece, California, British Petroleum et al. could have helped. And maybe even a couple of stupid trading algorithms. But not the high frequency guys.

I know, you're really, really sorry for ever suspecting otherwise.

UPDATE: CME concurs:
Some have questioned whether high-frequency traders (HFTs)
deploying so-called algorithmic trading methods
played a role in the May 6th incident. Certain HFTs
were active in both spot and futures markets during
this period as an ordinary course of business.
However, there is no visible support of the notion
that algorithmic trading models deployed in the
context of stock index futures traded on CME Group
exchanges caused the market fluctuations in

Rather, we believe that automated trading
contributes to market efficiencies, generally bolsters
liquidity and thereby contributes to the price
discovery function served by futures markets. This
view is supported in the academic literature where
one study found that “the move to screen trading
strengthens the simultaneity of price discovery in
the cash and futures markets and lessens the
existence of a lead-lag relationship.” Another study
concluded that their “results are consistent with the
hypothesis that screen trading accelerates the price
discovery process.”

Further, we find no evidence in CME stock index
futures of any undue concentration of activity
amongst algorithmic or any other types of traders.

UPDATE: It turns out NYSE's measures to slow the crash actually exacerbated it:
As several stocks declined sharply under heavy selling pressure, the New York Stock Exchange, one of the largest pools, stopped or slowed trading in particular stocks.

As part of that process, the NYSE held on to "buy" orders, in the hopes that it could gather enough of them to meet the selling demand. "Sell" orders that came to the NYSE were rerouted to other exchanges, which were not required to slow trading. Those other exchanges were soon overflowing with sell orders and didn't have enough buy orders to meet them, leading to the rapid decline in prices.

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