Tagged: Counterparty Tuesday

Many Tiny Trades

Posted on March 25, 2020

All 20 biggest points-losses for Dow Jones Industrials (DJIA) stocks in history have occurred under Regulation National Market System.

And 18 occurred from 2018-2020. Fifteen of the 20 biggest points-gains are in the last two years too, with all save one, in Mar 2000, under Reg NMS (2007-present).

It’s more remarkable against the backdrop of the Great Depression of the 1930s when the DJIA traded below 100, even below 50, versus around 20,700 now and small moves would be giant percentage jumps. Indeed, fifteen of the twenty biggest percentage gains occurred between 1929-1939. But four are under Reg NMS including yesterday’s 11.4% jump, 4th biggest all-time.

Just six of the biggest points-losses are under Reg NMS (we wrote this about the rule). But ranked second is Mar 16, 2020. And 19 of the 20 most volatile days on record – biggest intraday moves – were in the last two years, and all are under Reg NMS.

Statistically, these concentrated volatility records are anomalous and say what’s extant now in markets promotes volatility.  Our market is stuffed full of many tiny trades.

Volume the past five days has averaged 9.9 million shares per mean S&P 500 component, up 135% from the 200-day average.  But intraday volatility is up nearly 400%, trade-size measured in dollars is down 30%.

That’s why we’re setting volatility records. The definition of volatility is unstable prices.

I’m delighted as I’m sure CVX is that the big energy company led DJIA gainers yesterday, rising 22%.  But stocks shouldn’t post an excellent annual return in a day.

CVX liquidity metrics (volume is not liquidity!) show the same deterioration we see in the S&P 500, with intraday volatility up 400%, trade-size down 47%, daily trades up over 240% to 196,000 daily versus long-run average of about 57,000.

Doing way more of the same thing in tiny pieces means intermediaries get paid at the expense of investors.

Every stock by law must trade between the best national visible (at exchanges) bid to buy and offer to sell.  When volatility rises, big investors lose ability to buy and sell efficiently, because prices are constantly changing.

Regulators and exchanges have tried to deal with extraordinary volatility by halting trading.  We’ve tracked more than 7,500 individual trading halts in stocks since Mar 9 – twelve trading days.  Marketwide circuit breakers have repeatedly tripped.

Volatility has only worsened.

In financial crises, we inject liquidity to stabilize prices.  We can do the same in stocks by suspending the so-called “Trade Through Rule” requiring that stocks trade at a single best price, if the market is more than 5% volatile.

Trade size would jump, permitting big investors to move big money, returning confidence and stability to prices. We’ve proposed it three times to the SEC now.

Investors and public companies need to understand if the market is working. Let’s define “working.” The simplest measure is liquidity, which is not volume but dollars per trade, the amount one can buy or sell before price changes.  By that measure, the market has failed utterly during this tumult.

Let’s insist on a market capable of burstable bandwidth, so to speak, to handle surges.  Suspending Rule 611 of Reg NMS during stress is a logical strategy for the next time.

Let’s finish today by channeling the biblical apostles, who came to Jesus asking what would be the sign of the end of the age?  Here, we want to know what the sign is that market tumult is over.

At the extremities, no model can predict outcomes.  But given the nature of the market today and the behaviors dominating it, the rules governing it, we can inform ourselves.

This market crisis commenced Feb 24, the Monday when new marketwide derivatives traded for March expiration.  In the preceding week, demand for derivatives declined 5% at the same time Market Structure Sentiment topped.

We had no idea how violent the correction would be. But these signals are telling and contextual. They mean derivatives play an enormous role.

We had massive trouble with stocks right through the entire March cycle, which concluded Mar 20 with quad-witching.  Monday, new derivatives for April expiration began trading.

It’s a new clock, a reset to the timer.

You longtime clients know we watch Counterparty Tuesday, the day in the cycle when banks square the ledger around new and expired derivatives. That was yesterday.

That the market surged means supply undershot demand. And last week Risk Mgmt rose by 5% and was the top behavior – trades tied to derivatives, insurance, leverage. Shorting fell to the lowest sustained level in years. Market Structure Sentiment bottomed.

It’s a near-term nadir. The risk is that volatility keeps the market obsessed with changing the prices, which is arbitrage. Exchange Traded Funds depend on arbitrage (and led the surge in CVX).  Fast Traders do too. Bets on derivatives do.

The tumult ends in my view when big arbitragers quit, letting investment behavior briefly prevail.  We’ll see it. We haven’t yet.  The market may rise fast and fall suddenly again.

Form Follows Function

Posted on January 23, 2019

We’re told that on Friday Jan 18, the Dow Jones Industrial Average soared on optimism about US-China trade, then abruptly yesterday “global growth fears” sparked a selloff.

Directional changes in a day don’t reflect buy-and-hold behavior, so why do headline writers insist on trying to jam that square peg every day into the market’s round hole?

So to speak.

It’s not how the market works. I saw not a single story (if you did, send it!) saying options expired Jan 16-18 when the market surged or that yesterday marked rare confluence of new options trading and what we call Counterparty Tuesday when banks true up gains or losses on bets.

Both events coincided thanks to the market holiday, so effects may last Wed-Fri.

The point for public companies and investors is to understand how the market works. It’s priced, as it always has been, by its purposes. When a long-term focus on fundamentals prevailed, long-term fundamentals priced stocks.

That market disappeared in 2001, with decimalization, which changed property rights on market data and forced intermediaries to become part of volume. Under Regulation National Market System, the entire market was reshaped around price and speed.

Now add in demographics.  There are four competing forces behind prices. Active money is focused on the long-term. Passive money is focused on short-term central tendencies, or characteristics. Fast Traders focus on fleeting price-changes. Risk Management focuses on calculated uncertainties.

Three of these depend for success on arbitrage, or different prices for the same thing. Are we saying Passive money is arbitrage?  Read on. We’ll address it.

Friday, leverage expired. That is, winning bets could cashier for stock, as one would with the simplest bet, an in-the-money call option. The parties on the other side were obliged to cover – so the market soared as they bought to fulfill obligations.

Active money bought too, but it did so ignorantly, unaware of what other factors were affecting the market at that moment.  The Bank for International Settlements tracks nearly $600 trillion of derivatives ranging from currency and interest-rate swaps to equity-linked instruments. Those pegged to the monthly calendar lapsed or reset Friday.

Behavioral volatility exploded Friday to 19%. Behavioral volatility is a sudden demographic change behind price and volume, much like being overrun at your fast-food joint by youngsters buying dollar tacos, or whatever. You run out of dollar tacos.

That happened Friday like it did in late September. The Dow yesterday was down over 400 points before pulling back to a milder decline.

And there may be more. But it’s not rational thought. It’s short-term behaviors.

So is Passive money arbitrage?  Just part of it. Exchange-Traded Funds (ETFs) were given regulatory imprimatur to exist only because of a built-in “arbitrage mechanism” meant to keep the prices of ETFs, which are valueless, claimless substitutes for stocks and index funds, aligned with actual assets.

Regulators required ETFs to rely on arbitrage – which is speculative exploitation of price-differences. It’s the craziest thing, objectively considered. The great bulk of market participants do not comprehend that ETFs have exploded in popularity because of their appeal to short-term speculators.

Blackrock and other sponsors bake a tiny management fee into most shares – and yet ETFs manage nobody’s money but the ETF sponsor’s. They are charging ETF buyers a fee for nothing so their motivation is to create ETF shares, a short-term event.

Those trading them are motivated by how ETFs, index futures and options and stocks (and options on futures, and options on ETFs) may all have fleetingly different prices.

The data validate it.  We see it. How often do data say the same about your stock?  Investors, how often is your portfolio riven with Overbought, heavily shorted stocks driven by arbitrage bets?

What’s ahead? I think we may have another rough day, then maybe a slow slide into month-end window-dressing where Passive money will reweight away from equities again.  Sentiment and behavioral volatility will tell us, one way or the other.

Ask me tomorrow if behavioral volatility was up today. It’s not minds changing every day that moves the market. It’s arbitrage.