The saying goes that you’re better off keeping your mouth closed and looking like a fool than opening it and removing all doubt. Trading reminded us again about the wisdom in those words.

We’d warned that markets showed excessive arbitrage. Arbs capture net spreads between opposing trades and care little about price appreciation. When it’s high in the broad markets (and in specific issues, too), it often points to impending switches in the direction of money, say from one mix of assets to another. Why? Traders apparently detect algorithmic activity and move to profit from it.

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We were in Lake Jackson, TX, last week for Karen’s HS reunion. South Texas is a sweat lodge this time of year, but the Saint Augustine grass lies lush and luminescent under the sycamores and live oaks. And we saw not one tar ball on Surfside Beach in Freeport.

A word on trading: We expected money to move after options expirations, but changes to program-trading plans came early, on July 14, we observed in the data. So with expirations July 15-16, markets were shellacked when money shifted to other assets. The past two days have given us massive arbitrage around this shift and ahead of tomorrow’s volatility expirations. Thus, the week could end on a rough note, we fear. Continue reading →

Yesterday, I was forced to set aside comedian Dave Barry’s old book, Dave Barry is Not Taking This Sitting Down, and particularly his thoughtful essay on 1992 federal legislation imposing low-flow toilets on the American people, which produced an alarming increase in toilet-flushing-related carpel tunnel syndrome, to answer a question about sub-penny front-running in stock trading.

The question was: Can smart order-routing algorithms quoting in increments of less than a penny front run the national best bid or offer? Continue reading →

Prior to the 4th of July you might have heard us jeer, “That’s about as exciting as Iowa.”

Passing through last weekend, we had to concede that Iowa was in fact a place of surpassing and bucolic beauty, with its rolling corn-planted hills and manicured farms. The heartland at Independence Day reminded us that this land of ours and yours is jeweled.

Anyway, we’re a day late this week because it’s a long way from Bratenahl on Erie to the banks of the Platte.

Speaking of eerie, your management teams must be wondering what caused stocks to cross chasms today to the upside. Do you think investors suddenly decided stocks were cheap? To paraphrase Saturday Night Live…really? Continue reading →

Oscar Wilde said that illusion is the first of all pleasures. Of course he also wrote that anyone who lives within his means suffers from a lack of imagination.

Buttressed on either side with those brackets about illusion and means, let’s look today at what’s afflicting our market and why some institutions like transient trading when others don’t.

Vanguard, an institutional investor focused on passively managed funds, supports high-frequency trading. George Sauter, CIO for the Vanguard Group, wrote in the firm’s comment letter to the SEC on market structure that high-frequency volumes reduce trading costs through competition and tighter spreads. He quantifies the benefit to investors at roughly 10% over a decade. A passive fund providing 9% returns per annum would deliver only 8% returns without HFT. Continue reading →