Tagged: CFTC

Bang the Close

I find myself in an uncomfortable position.  I’m siding with a high-frequency trader.

There’s a key lesson here for investor-relations professionals about how prices are set, and it dovetails with why the bulk of volume concentrates around the open and close.

The title of this piece would be a great name for a rock band but it refers to submitting securities trades during the last 15 minutes of trading to affect how average prices are calculated. That’s “banging the close,” it’s said.

Venerable Chicago high-speed firm DRW, a proprietary trader focused on derivatives markets, has been accused by commodities regulators of manipulating prices on a key interest-rate swap. The alleged malfeasance occurred in 2011.

Normally firms settle with regulators when charged with rule-breaking. Founder Donald R. Wilson, a prominent figure in Chicago, insists DRW did nothing wrong and is battling the US Commodities Futures Trading Commission in court.

The CFTC says DRW submitted a thousand orders over seven months that didn’t conform with other prices during the vital last 15 minutes when “settlement prices,” or average prices for contracts and broker margin-requirements, are calculated. A broker serving as counterparty might have to furnish more capital if the price moves.

The CFTC is miffed because it believes DRW made money even though none of its bids produced a matched trade.  DRW says it was simply profiting on differences between the futures contract and the same product traded over-the-counter (that is, by brokers). The swaps contracts pay buyers (DRW was always the buyer) a fixed fee and sellers a floating one. Floaters lost, among them the now-defunct MF Global.

Let’s summarize for those who like me need an adult beverage after sorting this matter. The CFTC claims DRW manipulated prices for gains by putting in bids that weren’t like other bids. DRW says it bids what it thinks things are worth, not whether the price conforms to others’ views, and sometimes someone loses. That’s my interpretation.

What’s this got to do with IR and stock-trading? The IR job is predicated on helping investors understand why your shares are worth more than somebody else’s.  Are you manipulating prices then?  Of course not. And sometimes stocks decline.

Secondly, one reason Blackrock and Vanguard routinely beat your active holders for investment returns is because of stupid rules forcing prices to averages at the expense of those looking for outliers. Without outliers in markets, there’s no room for stock-pickers – the lifeblood of the IR profession. The market should reflect all prices, not averages.

It’s partly why volume is big in the morning and at the close.  Those prices are used to calculate averages. Your shares often move up or down early, toward the mean between, and then up or down into the close (see yesterday’s trading).  It could be argued that many algorithms are banging the close, which means banging is no aberration – or that the whole market is a series of continuous manipulations (don’t answer that!).

If DRW is a manipulator, then so was George Soros in the British pound. So are trading algorithms pursuing volume-weighted average prices because they undermine your effort to help your stock diverge from averages.

So is the Federal Reserve. The Fed sets artificial interest rates to manipulate broader ones, which it will likely do again Dec 14 (with $460 billion of reverse-repurchases on its balance sheet, another manipulation scheme, the Fed signals hike intentions). How is that different from DRW bidding at prices it believes reflect appropriate value?

If DRW is a price-manipulator, so was my dad.  On the cattle ranch of my youth, we’d take our animals to market and bid on them to push the price up to a level we thought proper. If the buyers didn’t like it, we bought the cattle back and took them home.

This would apparently have earned CFTC accusations of manipulating cattle prices.

Pardon me for bluntness but let’s knock off the crap, shall we? Rules that force all prices to the mean – which proliferate in equities and everywhere else now – defy supply and demand, foster mediocrity and promote sudden and irrational reversions to a mean.

I don’t prefer proprietary traders committing no long-term capital to budding businesses.  But.  If we want to reduce risk in the capital market, here’s an idea:  Let any buyer or seller price as he or she wishes. Suppose brokers could do it too. Maybe that would bring aftermarket support back to IPOs, creating new IR jobs again.

That’s my suggestion for the incoming SEC chair.

Chasing Spoofers

Apparently the market is very unstable.

This is the message regulators are unwittingly sending with news yesterday that UK futures trader Navinder Singh Sarao working from home in West London has been arrested for precipitating an epochal US stock-market crash.

On May 6, 2010, the global economy wore a lugubrious face. The Greeks had just turned their pockets out and said, “We’re bollocks, mate.”  (Thankfully, that problem has gone away.  Oh. Wait.) The Euro was on a steep approach with the earth. Securities markets were like a kindergarten class after two hours without some electronic amusement device.

By afternoon that day, major measures were off 2% and traders were in a growing state of unease. The Wall Street Journal’s Scott Patterson writing reflectively in June 2012, interviewed Dave Cummings, founder of seminal high-frequency firm TradeBot. Heavy volume was scrambling trading systems, Patterson wrote, leading to disparities in prices quoted on various exchanges. The decline became so sharp, Cummings told Patterson, that he worried it wasn’t going to right itself. If the data was bad, TradeBot would be spreading contagion like a virus.

Ah, but wait. Regulators now say mass global algorithmic pandemonium May 6, 2010 was just reaction to layered stock-futures spoofing out of Hounslow, a London borough featuring Osterly Park, Kew Bridge and a big Sikh community. If you think the Commodity Futures Trading Commission’s revelry over finding the cause of the Flash Crash just north of the Thames and west of Wimbledon stretches the bounds of credulity, you should.

Mr. Sarao is accused of plying “dynamic layering” in e-mini S&P 500 futures, a derivatives contract traded electronically representing a percentage of a standard futures contract. It’s called an ideal beginner’s derivative because it’s highly liquid, trades around the clock at the Chicago Mercantile Exchange, and offers attractive economics. (more…)