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[TFF] HFT - The Facts - Exploratory trading is a form of manipulation designed to te...

TFF — 5/12/2013 9:34:23 PM

HFT - The Facts -

Exploratory trading is a form of manipulation designed to test the market's reaction to a trade.

nanex.net

[TFF] Intercontinental Exchange to Aquire NYSE Euronext ...

TFF — 12/20/2012 9:10:17 AM

Intercontinental Exchange to Aquire NYSE Euronext

December 20, 2012 – IntercontinentalExchange (NYSE: ICE), a leading operator of global markets and clearing houses, and NYSE Euronext (NYSE: NYX), the preeminent global equity, equity options and fixed income derivatives market operator, today announced a definitive agreement for ICE to acquire NYSE Euronext in a stock-and-cash transaction. The acquisition combines two leading exchange groups to create a premier global exchange operator diversified across markets including agricultural and energy commodities, credit derivatives, equities and equity derivatives, foreign exchange and interest rates. With leading clearing capabilities, the combined company will be well positioned to deliver efficiencies while serving customer demand for clearing and risk management globally.

Under the terms of the agreement, which was unanimously approved by the Boards of both companies, the transaction is currently valued at $33.12 per NYSE Euronext share, or a total of approximately $8.2 billion, based on the closing price of ICE’s stock on December 19, 2012. NYSE Euronext shareholders will have the option to elect to receive consideration per NYSE Euronext share of (i) $33.12 in cash, (ii) 0.2581 IntercontinentalExchange common shares or (iii) a mix of $11.27 in cash plus 0.1703 ICE common shares, subject to a maximum cash consideration of approximately $2.7 billion and a maximum aggregate number of ICE common shares of approximately 42.5 million. The overall mix of the $8.2 billion of merger consideration being paid by ICE is approximately 67% shares and 33% cash. The transaction value of $33.12 represents a 37.7% premium over NYSE Euronext’s closing share price on December 19, 2012.

NYSE Euronext shareholders will own approximately 36% of ICE shares post-transaction.

The cash portion of the transaction will be funded by a combination of cash on hand and existing ICE credit facilities.

The transaction is expected to close in the second half 2013, subject to regulatory approvals in Europe and the U.S. and approval by shareholders of both companies.

The majority of run-rate expense synergies of $450 million are expected to be achieved in the second full year post-closing.

Earnings accretion of greater than 15% is expected in the first year post-closing.

As a result of the transaction, ICE clearing will be more capital efficient and provide operational efficiencies for clearing members.

ICE is committed to preserving the NYSE Euronext brand. ICE will maintain dual headquarters in Atlanta and New York. New York headquarters will be located in the Wall Street building, home to the iconic trading floor. ICE will also open a new midtown Manhattan office in June 2013.

ICE is also committed to maintaining the position of NYSE Liffe in London as a leading international market operator for derivatives products, including its benchmark interest rate complex.

ICE intends to explore an initial public offering of Euronext as a Continental European-based entity following the closing of the acquisition if market conditions and European policy makers support the offering.

Jeffrey C. Sprecher will continue as Chairman and CEO of the combined company and Scott A. Hill as CFO. Duncan L. Niederauer will be President of the combined company and CEO of NYSE Group. Four members of the NYSE Euronext Board of Directors will be added to the ICE Board of Directors which will be expanded to 15 members.

"Our transaction is responsive to the evolution of market infrastructure today and offers a range of growth opportunities, while enhancing competition in US and European markets and broadening our ability to address new markets and offer innovative products and services on a global platform," said ICE Chairman and CEO Jeffrey C. Sprecher. "We believe the combined company will be better positioned to compete and serve customers across a broad range of asset classes by uniting our global brands, expertise and infrastructure. With a track record of growth and returns, clearing and M&A integration, we are well positioned to transform our combined companies into a premier global exchange operator that remains a leader in market evolution."

“The Board of NYSE Euronext carefully considered a range of strategic alternatives and concluded that ICE is the ideal partner for NYSE Euronext in an evolving market landscape," said Jan-Michiel Hessels, Chairman of the Board of NYSE Euronext. "We look forward to working with ICE to complete this compelling, value-enhancing combination."

“This transaction leverages the strength of our iconic brand and the value we have created in our global equity and derivatives franchises – positioning the business for solid long-term growth and development,” said Duncan L. Niederauer, CEO of NYSE Euronext. “We are bringing together two highly complementary businesses, creating an end-to-end multi-asset portfolio that will be strongly positioned to serve a global client base and capture current and future growth opportunities.”

Benefits of the transaction include:

Financial

Acquisition will unlock significant value through the achievement of merger related cost synergies. ICE has successfully integrated more than a dozen acquisitions in the last decade, with a track record of delivering on or exceeding synergy commitments.

The transaction is expected to be highly accretive to earnings in the first year after closing and produce returns on invested capital above the transaction’s cost of investment beginning in year two.

Model delivers strong operating leverage while preserving healthy levels of recurring revenues and participation in a market recovery, positioned to perform well in a rising interest rate and improved equity market environment.

Strong cash flows and balance sheet of the combined company support continued investments in growth initiatives while facilitating rapid deleveraging post-close. ICE, upon closing of the transaction intends to adopt a dividend policy that will provide for an annual dividend payment of approximately $300 million. This amount represents the aggregate amount of NYSE Euronext’s current annual dividend payment.

Provides for diversification among multiple asset classes and expands ICE’s reach into new markets, including the world’s largest asset class - interest rates - at current cyclical lows.

Operational

Acquisition creates an unparalleled operator of global exchanges and clearing houses for agricultural and energy commodities, credit derivatives, equities and equity derivatives, foreign exchange and interest rates.

Benefits from strong global presence, infrastructure and brands across international markets.

NYSE Liffe execution and clearing will be merged into ICE Clear Europe, creating an efficient clearing model poised for growth as interest rate markets recover and interest rate swap clearing develops.

ICE has proven transition capabilities and successfully launched ICE Clear Europe in November 2008, transferring approximately 26.5 million contracts and over $16 billion in initial margin.

Competition and Market Structure

Builds on track record of improving market transparency and expands resources to address challenges and opportunities in equity market structure.

Enhances innovation and competitiveness within U.S. and European rate markets.

Operational and capital efficiency in implementation of new regulatory requirements with compliant solutions already in place.

Emphasis on market safety and security via high-performance, integrated technology infrastructure.

ICE’s lead financial advisor is Morgan Stanley; further financial advice is being provided by BMO Capital Markets Corp., Broadhaven Capital Partners, JPMorgan, Lazard, Societe Generale Corporate & Investment Banking, and Wells Fargo Securities, LLC. ICE legal advisors are Sullivan & Cromwell LLP and Shearman & Sterling LLP. The principal financial advisers to NYSE Euronext are Perella Weinberg Partners and BNP Paribas. Legal advisers to NYSE Euronext are Wachtell, Lipton, Rosen & Katz, Slaughter & May, and Stibbe N.V. Further financial advice to NYSE Euronext is being provided by Blackstone Advisory Partners, Citigroup, Goldman Sachs & Co. and Moelis & Co.

Investor Conference Call
An investor conference call will be held at 8:45 a.m. ET/1:45 p.m. GMT today, December 20, 2012, and is available via the ICE and NYSE Euronext websites. U.S. participants may dial 1 (866) 700-7441 and international participants may dial +1 (617) 213-8839. The participant code is 20593477. The call will be available for replay on each investor website. Media may participate in the call on a listen-only basis.

ICE-CORP

About IntercontinentalExchange, Inc.
IntercontinentalExchange, Inc. (NYSE: ICE) is a leading operator of regulated futures exchanges and over-the-counter markets for agricultural, credit, currency, emissions, energy and equity index contracts. ICE Futures Europe hosts trade in half of the world’s crude and refined oil futures. ICE Futures U.S. and ICE Futures Canada list agricultural, currencies and Russell Index markets. ICE is also a leading operator of central clearing services for the futures and over-the-counter markets, with five regulated clearing houses across North America and Europe. ICE serves customers in more than 70 countries. For more information, please visit: www.theice.com.

The following are trademarks of IntercontinentalExchange, Inc. and/or its affiliated companies: IntercontinentalExchange; IntercontinentalExchange & Design; ICE; ICE and block design; ICE Futures Canada; ICE Futures Europe; ICE Futures U.S.; ICE Clear Credit; ICE Clear Europe; ICE Clear U.S.; ICE Clear Canada; The Clearing Corporation; U.S. Dollar Index; ICE Link and Creditex. All other trademarks are the property of their respective owners. For more information regarding registered trademarks owned by IntercontinentalExchange, Inc. and/or its affiliated companies, see theice.com.

About NYSE Euronext
NYSE Euronext (NYSE: NYX) is a leading global operator of financial markets and provider of innovative trading technologies. The company’s exchanges in Europe and the United States trade equities, futures, options, fixed-income and exchange-traded products. With approximately 8,000 listed issues (excluding European Structured Products), NYSE Euronext’s equities markets – the New York Stock Exchange, NYSE Euronext, NYSE MKT, NYSE Alternext and NYSE Arca – represent one-third of the world’s equities trading, the most liquidity of any global exchange group. NYSE Euronext also operates NYSE Liffe, one of the leading European derivatives businesses and the world’s second-largest derivatives business by value of trading. The company offers comprehensive commercial technology, connectivity and market data products and services through NYSE Technologies. NYSE Euronext is in the S&P 500 index. For more information, please visit: nyx.com.

[TFF] Monster Orders upholstered Exchange ...

TFF — 11/29/2012 7:19:05 AM

Monster Orders upholstered Exchange

Stockholm Stock Exchange was paralyzed on Wednesday morning of a purchase order of over 4.2 billion index futures. The value of words corresponding to 131 times Sweden's gross domestic product, and the stock market witnessed technical problems.

The giant order december semester in OMXS30, a security equivalent to a basket consisting of the Stockholm Stock Exchange's 30 largest companies, and where trade is very important for the overall pricing of the stock market.

The order was on buy side of the order book and covered more than 4.2 billion futures, to a unit price of almost 107,000 dollars. It gives a theoretical value of 459 561 500 030 000, ie nearly 460 trillion dollars.Sweden's gross domestic product, by comparison, amounted in 2011 to more than 3500 billion.

- Troubleshooting is underway and we communicate constantly updates to our members, writes Carl Norell.

On Thursday, the Stockholm Stock Exchange's derivatives trading open as usual.

[TFF] Nanex: Investors Need to Realize The Machines Have Taken Over ...

TFF — 10/7/2012 6:35:52 PM

Nanex: Investors Need to Realize The Machines Have Taken Over

youtube.com!

[TFF] Wall Street sees Knight as software risk wake-up call ...

TFF — 8/5/2012 7:52:57 AM

Wall Street sees Knight as software risk wake-up call

Reuters – Fri, Aug 3, 2012 8:16 PM EDT

By Lauren Tara LaCapra and Dan Wilchins

(Reuters) - Wall Street banks and brokers are poring over their trading systems and rethinking the way they test software to make sure they don't become the next Knight Capital Group, the trading firm whose survival was imperiled by a software glitch on Wednesday.

Knight Capital's $440 million loss from errant trades, which has forced the company to consider selling all or part of itself, is the third time in five months that technical bugs have caused trouble for Wall Street players.

Executives at trading firms said they are debating among one another whether new regulations could prevent these snafus. But they also said glitches were a wake-up call for firms to improve their controls on their own, without being pushed into it. At a time when Wall Street is cutting costs, spending money on better systems to test software and manage risk could be an expensive proposition.

"We want to make sure that what happened to Knight doesn't happen to us," said the head of one investment bank. His company was looking carefully at how it tests new trading systems, to make sure traders know when new systems are being implemented and can be on the lookout for suspicious activity during those periods.

Their efforts face plenty of obstacles. As more trading has moved from exchange floors to computers over the last decade, the speed of execution jumped along with the potential for cascading problems.

Trading firms, market makers, brokers, investment banks, and exchanges and other trading venues are linked in a network of complex computer systems that compete to execute trades as fast as possible. That competition, combined with the never-ending array of new rules, forces market participants to constantly improve their systems.

But the intricate network of players and systems creates a much wider range of potential problems for trading systems, making testing costly and difficult. Good testing requires a firm to imagine everything that can possibly go wrong and how the system will interact with other systems. Predicting every plausible scenario is not easy, said one trading head at a major Wall Street firm.

Regulators have set up "circuit breakers" that require exchanges to suspend trading in stocks that move too much too quickly. But dealers and other market players usually have even more sophisticated circuit breakers for their own trading.

"You need an algorithm to monitor the trading algorithm," said John Bates, chief technology officer at Progress Software, which provides trading software.

Knight appeared to lack these sorts of circuit breakers, or at least did not implement them well enough, traders said.

Two other major trading glitches have beset Wall Street since March. BATS Global Markets, an exchange, was unable to complete its own initial public offering because of a technical problem. Nasdaq botched the market debut of Facebook due to systems bugs, costing it tens of millions of dollars, while UBS AG lost more than $350 million in trading Facebook shares and is blaming Nasdaq.

LOWER VOLUMES, HIGHER PRESSURE

Dealers don't always do a great job of testing, said Colin Clark, a developer with Cloud Event Processing, a firm that works with big Wall Street banks and exchanges on software and technology.

"They're not investing enough in testing now," Clark said, noting the pressure banks face to cut costs.

U.S. stock trading volume is 40 percent below its peak volume in 2009, according to Tabb Group, falling from an average of 12 billion trades a day to 6 million to 7 million currently. That decline has weighed on profits at firms, and strained the willingness of many to invest in unglamorous areas like testing systems, said Larry Tabb, founder of Tabb Group, a consulting firm that focuses on capital markets.

"There are fewer people minding the store, and the people in place are stretched too thin," Tabb said.

But others on Wall Street dismissed the notion that dealers are not investing enough in their systems, noting that dealers spend millions on technology in part to be more efficient and reduce staffing levels.

In addition to testing new systems, firms are checking their mechanisms to protect them from bad trades. Most dealers have systems that automatically stop trading, or at least generate warnings for traders, when volumes or price movements are suspicious.

Dealers can try to improve their own systems, but it is possible that new rules could prevent breakdowns as well. One idea that dealers have discussed in the wake of the Knight Capital mess is eliminating "market orders," or orders that are executed at whatever the prevailing market price is. Retail investors often place market orders.

Customers could instead be required to place "limit orders" that specify the maximum price at which they will buy a stock, for example. With limit orders, if the market price of a stock surges because of technical glitches, many orders to buy shares would not be executed.

Another idea dealers have discussed is to slow down trading, to ensure that they have a handle on what they are doing at all times.

"If so many trades are happening in a millisecond, it's hard to keep up with everything you're doing," said one of the senior Wall Street traders.

(Reporting By Lauren Tara LaCapra, Jed Horowitz, Olivia Oran, Dan Wilchins, and Nicola Leske, writing by Dan Wilchins; Editing by Alwyn Scott and Richard Chang)

[Allan C.] Hard to believe "Trading Places" is almost thirty years old...

Allan C. — 7/31/2012 5:32:02 PM

[TFF] The End of An Era: ICE Closes NY Trading Floor ...

TFF — 7/30/2012 11:53:11 AM

The End of An Era: ICE Closes NY Trading Floor

The exchange depicted in the popular 1983 film Trading Places, has a history dating back to the New York Cotton Exchange, which was founded in 1870 and later became the Coffee, Sugar and Cocoa Exchange.

By Melanie Rodier
@mrodier

JULY 27, 2012

After 142 years, the frenzy of the open-outcry commodities markets in New York epitomized in the 1983 movie 'Trading Places' (see video below), where traders gesture and yell across pits to trade, is no more.

Formerly known as the New York Board of Trade, the ICE Futures U.S exchange was the main venue for U.S futures and options on cocoa, coffee, cotton, orange juice and sugar.

IntercontinentalExchange, which bought the exchange in 2007, said yesterday that from October 22 all options listed on ICE Futures U.S will trade exclusively through its electronic trading system.Its history dates back to the New York Cotton Exchange, founded in 1870, which later became the Coffee, Sugar and Cocoa Exchange. In 1998, they merged to form the New York Board of Trade.

The move to close down its trading floor comes four years after ICE shifted all futures trading to computers. Still, the trading floor continued to be a venue for options on futures as these were seen as too complex to trade only electronically.

But in the past year, as options functionality on the ICE platform increased, electronic trading of options accelerated. In April 2011, electronic execution accounted for approximately 10% of options volume, compared to more than 75% today, ICE said in a release.

"The rapid adoption of electronic trading by options market participants is strong validation of the capabilities ICE has built into its electronic trading platform," said Ben Jackson, president of ICE Futures U.S. "

In January, ICE imposed a $6,000 annual access and usage fee on floor traders who failed to meet volume targets, the Financial Times reports.

About 100 floor traders are still in action today, down from 150 a year ago and 330 when ICE ended floor-based futures trading in March 2008.

"You could shoot a shot through the floor and not hit anybody," a cotton broker told Reuters, speaking about a recent visit to the floor.

“I don’t see how the floor closing better serves the customer or the merchant that uses options products,” Thomas Butler, a cotton broker who chairs the ICE executive floor committee, told the FT. “I feel it was a little bit premature, but inevitable.”

ICE Futures U.S rents space on the seventh floor of the New York Mercantile Exchange building from its rival CME Group, under a lease that expires in June 2013.

The New York Board of Trade had been in the space in 2003, after the September 11 attacks destroyed its former location in the World Trade Center.

The FT reports that in 2013, IntercontinentalExchange plans to move to the office space in Manhattan that was formerly occupied by disgraced futures broker MF Global – whose primary regulator was CME Group. An electronic “dealing room” will be available for brokers who need one, ICE said.

[Dominick] Well if that's the reason. Then the red flags should be programmable in the tra...

Dominick — 7/21/2012 1:17:10 PM

Well if that's the reason. Then the red flags should be programmable in the trading software alerting compliance and management unable to be bypassed by the trader.

[TFF] Billion Dollar Trading Losses: Is Biology to Blame? ...

TFF — 7/20/2012 4:40:04 PM

Billion Dollar Trading Losses: Is Biology to Blame?

By Morgan Korn | Daily Ticker – Wed, Jul 18, 2012 2:06 PM EDT

JPMorgan. UBS. Societe Generale. These banks have been rocked by gargantuan trading losses in recent years because of excessive risk taking (and trades gone bad) by one or two "rogue" traders.

How can erroneous decisions made by one individual total billions of dollars in damages for his or her firm? John Coates, a former Wall Street trader and author of the book " The Hour Between Dog and Wolf," says biology plays a central role in the infamous trading scandals. A former trader at Deutsche Bank, Coates left Wall Street to study neuroscience and finance at the University of Cambridge. His goal was to find the answer to the question that has perplexed experts for years: why do traders make the decisions they do?

"I am not sure greed is the primary motivation here," Coates says in an interview with The Daily Ticker. "There are institutional incentives to maximize the variance of your trading results. But underlying it all is human behavior."

Coates says traders can succumb to the "winner effect" — a model that has been used by scientists to describe animal behavior. The "winner" becomes more confident and seeks more risk after winning a fight (for animals it's turf; for traders it's stocks) and the biology of that individual (or animal) changes to prepare for more competition.

"This is actually a biologically driven phenomenon," he says. "When we're on a winning streak, in our brain certain chemicals and electrical signals are encouraging us to take more and more risk. Anybody who's spent time on a trading floor and who's taken large financial risks knows that when they are making these decisions their bodies are completely involved in the decision making."

Traders' hearts beat faster, testosterone levels shoot up and traders can actually become physically and psychologically immune to risk by developing a high tolerance for it. Some traders even lose touch with fear, Coates says.

Ultimately this excessive risk taking backfires, leaving financial firms and investors with enormous trading losses. But Coates says there are ways to prevent these catastrophic biological effects on global markets. Risk managers should remove traders on a winning streak by pulling them off the trading floor, even for weeks at a time. Managers can follow the lead of sports scientists by employing "physiological toughening" — physical training regimes that builds one's resilience to the peaks of exuberance and pessimism.

"Every blowup I've seen on Wall Street or in London with losses north of a billion dollars have occurred at the hands of a trader who is at the end of a multi-year winning streak," he adds. "Traders on a winning streak — those you should be worried about."

[TFF] SEC approves plan to curb volatility in stocks ...

TFF — 6/1/2012 9:13:49 PM

SEC approves plan to curb volatility in stocks

Published: Friday, 1 Jun 2012 | 7:44 PM ET

(Reuters) - U.S. securities regulators have approved a one-year pilot program for a plan designed to protect equity markets from volatile price swings in the wake of the "flash crash" of May 6, 2010.

The Securities and Exchange Commission said on Friday that beginning in February, individual U.S.-listed stocks will be prevented from trading outside a range based on recent prices.

The so-called "limit up-limit down" initiative would pause trading for five minutes for securities if attempted trades remain outside the price band for more than 15 seconds. During that timeout period, traders could assess whether the move was based on fundamentals.

"In today's complex electronic markets, we need an automated and appropriately calibrated way to pause or limit trading if prices move too far too fast," SEC Chairman Mary Schapiro said in a statement.

The SEC worked closely with the exchanges and the Financial Industry Regulatory Authority (FINRA) to come up with market structural fixes aimed at preventing a repeat of the flash crash, which temporarily wiped out about $1 trillion in paper value in the stock market in a matter of minutes.

For some, the unprecedented market drop confirmed fears that high-speed, automated trading represented a systemic risk to the foundations of capitalism. For others, it was an embarrassing blip that called for measured adjustments to an otherwise well-functioning market.

The new trading bands will replace existing single-stock circuit breakers, which halt trading for five minutes in U.S. stocks and exchange-traded funds (ETFs) when they move more than 10 percent in five minutes.

"Trading bands are not in and of themselves counter to market pricing and they can lend a degree of stability to a market," said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey. "It's a very logical next step."

For more liquid securities in the S&P 500 Index, Russell 1000 Index, and certain exchange-traded products, the band will be 5 percent above and below the average price of the security over the preceding five-minute period. For other listed securities the level will be 10 percent.

The percentages will be doubled during the opening and closing periods and broader price bands will apply to securities priced $3 per share or less.

MARKET-WIDE CIRCUIT BREAKERS

The plan also updates existing market-wide circuit breakers that, when triggered, halt trading in all exchange-listed securities on U.S. markets.

The existing market-wide circuit breakers were adopted in October 1988 and have been triggered only once, in 1997. The changes lower the percentage-decline threshold for triggering a market-wide trading halt and shorten the amount of time that trading is halted.

The revised rules tighten the market decline percentage thresholds needed to trigger the market-wide circuit breaker to 7, 13, and 20 percent from the prior day's closing price, rather than declines of 10, 20, or 30 percent.

They also shorten the duration of trading halts that do not close the market for the day to 15 minutes, from 30, 60, or 120 minutes.

The broader S&P 500 Index will be used as the pricing reference to measure a market decline, rather than the Dow Jones Industrial Average, which is currently being used.

The SEC said it approved the proposals, which have to be in place by February 4, for a one-year pilot period. During that time the exchanges, FINRA, and the SEC will assess their effectiveness.

The SEC said it is also considering what additional measures may be needed, including establishing a consolidated audit trail system to better track orders and trades in securities across the national market system.

(Reporting by John McCrank; Additional reporting by Jonathan Spicer and Sarah Lynch; Editing by Phil Berlowitz, Gary Hill)

[TFF] Nanosecond Trading Could Make Markets Go Haywire ...

TFF — 2/16/2012 1:30:00 PM

Nanosecond Trading Could Make Markets Go Haywire

wired.com

By Brandon Keim Email Author February 16, 2012 | 6:30 am | Categories: Tech

The afternoon of May 6, 2010 was among the strangest in economic history. Starting at 2:42 p.m. EDT, the Dow Jones stock index fell 600 points in just 6 minutes. Its nadir represented the deepest single-day decline in that market’s 114-year history. By 3:07 p.m., the index had rebounded. The “flash crash,” as it came to be known, was big, unexpected and scary — and a new study says flash events actually happen routinely, at speeds so fast they don’t register on regular market records, with potentially troubling consequences for market stability.

The analysis involved five years of stock market trading data gathered between 2006 and 2011 and sorted in fine-grained, millisecond-by-millisecond detail. Below the 950-millisecond level, where computerized trading occurs so quickly that human traders can’t even react, no fewer than 18,520 crashes and spikes occurred. The study’s authors call those events “financial black swans,” though they’re so common that the black swan label probably doesn’t fit anymore.

Moreover, those events fell into patterns that didn’t fit market patterns seen at other time scales. It’s as if computerized trading has created a new world, one where the usual rules don’t apply, populated by algorithms and only dimly understood by the people who made them. The extent to which that world influences our own — perhaps making events like the 2010 flash crash more likely, or causing markets to be generally more volatile — is an open question.

“There’s this whole world below 650 milliseconds. It’s like landing on another planet,” said Neil Johnson, a complex systems specialist at the University of Miami and co-author of the study, released Feb. 7 on arXiv. “It’s an enormous part of the market which is out of human reach. We have a glimpse of the kind of ecology that’s going on down there.”

Red line represents the frequency of sub-650 millisecond flash crashes, and blue the frequency of flash spikes, between January 2006 and February 2011. The black spike is the S&P 500 index.Image: Johnson et al./arXiv

Until recently, trading was the preserve of humans. Imagine a stock market and you likely envision a loud, crowded trading floor, a scene out of Wall Street. But in 1998, after the U.S. Securities and Exchange Commission authorized the first electronic exchanges, computer trading programs entered markets as equals to humans.

The programs are designed to trade enormous volumes of stocks, bonds and other financial instruments at superfast speeds, taking advantage of second-to-second fractional price shifts and market trends. It’s now estimated that high-frequency computer trading accounts for 70 percent of all equity trades. While some activity does occur at speeds with which humans can interact, much of it falls beyond the limits of human response time.

(One new computer chip built specifically for high-frequency trading can prepare trades in .000000074 seconds; a proposed $300 million transatlantic cable is being built just to shave 0.006 seconds off transaction times between New York City and London.)

In the early years of computer trading, algorithms were profitable and concerns rare. Designers and investors took their money and didn’t think much about what Johnson and co-authors call “ultrafast machine ecology.” After the 2010 flash crash, however, mainstream economists wondered if high-frequency trading systems might sometimes get weird and unpredictable. A $4.1 billion automated sale was ultimately blamed for triggering that crash, and economists started asking questions about the new, hazy relationships between machines and markets.

“We are certainly witnessing one of the major transitions in the history of financial markets,” said automated trading researcher John Cartlidge of the University of Bristol, who was not involved in new study. “Economic theory has always lagged behind economic reality, but now the speed of technological change is widening that gap at an exponential rate. The scary result of this is that we now live in a world dominated by a global financial market of which we have virtually no sound theoretical understanding.”

In the new study, researchers led by Johnson and simulation engineer Brian Tivnan of the University of Vermont analyzed millisecond-scale price logs from 600 markets. The numbers were gathered by Nanex, a Chicago-based company that sells live market data.

'We now live in a world dominated by a global financial market of which we have virtually no sound theoretical understanding.'
From this analysis emerged records of 18,520 sub-950-millisecond crashes and spikes — far more than they, and perhaps almost anyone, expected. Equally as striking as these events’ frequency was their arrangement: While market behavior tends to rise and fall in patterns that repeat themselves, fractal-style, in periods of days, weeks, months and years, “that only holds down to the time scale at which human stop being able to respond,” said Johnson. “The fractal gets broken.”

Why this should happen isn’t exactly clear, but the researchers think it reflects differences between human and computer trading strategies. Whereas people have many different strategies, high-frequency programs “sacrifice diversity for speed,” said Tivnan. “You see a lot more homogeneity at the sub-second scale than we see above 1,500 ms.” In the researchers’ models of high-frequency trading markets, a variety of algorithms eventually evolved into a few stripped-down, optimized forms.

With many algorithms converging on just a few different strategies, the high-frequency trading market could become vulnerable to systemwide herd behaviors. Fortunately for us, the market seems to rebound from spikes almost as immediately as they occur — Johnson and Tivnan likened the effect to a “coiled spring” returning to form — but as seen in May 2010, this might not always happen.

Johnson and Tivnan also used another metaphor to describe the flash crashes and spikes: fractures. The events could be imagined as microfractures in the wing of an aircraft, accumulating unnoticeably until some critical, breakage-causing mass is reached. To that end, they found a correlation between rising frequencies of sub-950-ms flash events, market volatility after 2008, and the May 2010 flash crash. The 10 stocks most prone to crash-and-spiking were all financial companies, with Morgan Stanley, Goldman Sachs and Wells Fargo topping the list.

“Lay the occurrences of spikes and crashes against each other on the same timeline, and then look at the movement of a major index like the Standard & Poor’s 500. What’s particularly interesting is that dramatic increases of spikes and crashes coincided with major movements in the S&P index itself,” said Tivnan.

However, it’s uncertain whether this correlation reflects a cause-and-effect relationship. It could conceivably be just a coincidence. “The results are provocative, but need more statistical testing to be something you can reliably interpret,” said complex systems theorist Doyne Farmer of the Santa Fe Institute, who was not involved in the new study.

Blue bars represent the distribution of different high-frequency trading strategies; red bars represent strategies that could be added at critical points to reduce flash behaviors. Image: Johnson et al./arXiv

Uncertainties notwithstanding, the paper is still “an extremely important contribution to solve the puzzle of financial complexity,” said econophysicist Tobias Preis of the Swiss Federal Institute of Technology, who studies patterns that precede market bubbles. Cartlidge called the paper “timely and important,” and said the findings are “likely to have a significant impact on market participants and regulators alike.”

The question of regulation is a tricky one. In the aftermath of May 2010, federal U.S. regulators introduced so-called “circuit breakers” that automatically halt trading if a stock price falls too much, too fast. But whether this actually works isn’t yet known. “Currently, we’re having trouble even observing at that level of resolution, let alone regulating it,” said Tivnan.

Tivnan also works for the MITRE Corporation, a nonprofit engineering and technology consultancy that provides research support to U.S. regulatory agencies. Both the U.S. and European Union are actively investigating further intervention in the machine trading world.

Johnson and Tivnan propose a subtler approach than circuit-breakers, one that would “steer” automated markets by introducing rogue algorithms when herd behaviors appear imminent. Farmer wants markets altered to become slower, with trades occurring intermittently — once per second or once even per minute, rather than constantly — and speed de-emphasized. That would allow algorithm designers “to focus on the quality of decision-making, rather than the time it takes,” said Farmer, who preaches caution in designing new regulation.

“There’s a danger of Europeans doing some changes they haven’t thought through, and there’s danger of the United States not changing things they need to change,” Farmer said. “It’s hard to think these things through, because nobody understands them.”

Citation: “Financial black swans driven by ultrafast machine ecology.” By Neil Johnson, Guannan Zhao, Eric Hunsader, Jing Meng, Amith Ravindar, Spencer Carran and Brian Tivnan. arXiv, 7 February 2012

[TFF] A Romance With Risk That Brought On Panic ...

TFF — 12/12/2011 10:09:04 AM

A Romance With Risk That Brought On Panic

By AZAM AHMED, BEN PROTESS and SUSANNE CRAIG | New York Times – 1 hour 10 minutes ago

Soon after taking the reins of MF Global in 2010, Jon S. Corzine visited the Wall Street firm's Chicago offices for the first time, greeting the brokers, analysts and sales staff there.

One broker, Cy Monley, caught Mr. Corzine's eye. Unknown to MF Global's top management in New York, the employee, whose job was to match buyers and sellers in energy derivatives, was also trading a small account on the side, using the firm's capital.

"How are you making money on side bets? What else are you guys doing to make money here?" Mr. Corzine asked enthusiastically, his eyes widening, the broker recalled. The new chief executive grabbed a seat and spent an hour questioning Mr. Monley as other top executives from New York hovered impatiently nearby.

Although Mr. Corzine had been a United States senator, governor of New Jersey, co-head of Goldman Sachs and a confidant of leaders in Washington and Wall Street, he was at heart a trader, willing to gamble for a rich payoff.

Dozens of interviews reveal that Mr. Corzine played a much larger, hands-on role in the firm's high-stakes risk-taking than has previously been known.

An examination of company documents and interviews with regulators, former employees and others close to MF Global portray a chief executive convinced that he could quickly turn the money-losing firm into a miniature Goldman Sachs.

He pushed through a $6.3 billion bet on European debt - a wager big enough to wipe out the firm five times over if it went bad - despite concerns from other executives and board members. And it is now clear that he personally lobbied regulators and auditors about the strategy.

His obsession with trading was apparent to MF Global insiders over his 19-month tenure. Mr. Corzine compulsively traded for the firm on his BlackBerry during meetings, sometimes dashing out to check on the markets. And unusually for a chief executive, he became a core member of the group that traded using the firm's money. His profits and losses appeared on a separate line in documents with his initials: JSC.

Yet few appeared willing to check Mr. Corzine's trading ambitions.

The review of his tenure also sheds new light on the lack of controls at the firm and the failure of its watchdogs to curb outsize risk-taking. The board, according to former employees, signed off on the European bet multiple times. And for the first time it is now clear that ratings agencies knew the risks for months but, as they did with subprime mortgages, looked the other way until it was too late, underscoring how three years after the financial crisis, little has changed on Wall Street.

MF Global filed for bankruptcy on Oct. 31. As the firm spun out of control, it improperly transferred some customer money on Oct. 21 - days sooner than previously thought, said people briefed on the matter. And investigators are now examining whether MF Global was getting away with such illicit transfers as early as August, one person said, a revelation that would point to wrongdoing even before the firm was struggling to survive.

The consequences of the firm's collapse have been severe: Some $1 billion in customer money remains missing and thousands of clients, including small farmers in Kansas or hedge funds in Connecticut, still do not have nearly a third of their funds.

Some of that money may never be recovered if, as some regulators now fear, MF Global used it to cover trading losses and replenish overdrawn bank accounts.

The bet on European sovereign debt is not thought to be directly connected to the missing money. But the fears about the firm's exposure to Europe tipped an anxious market, causing a run on MF Global that regulators suspect led the firm to fight for its life using customer money.

Mr. Corzine has not been accused of any wrongdoing. Through a spokesman, he declined to comment for this article.

While Mr. Corzine apologized for the firm's collapse when he appeared before the House Agriculture Committee on Thursday, he has continued to defend the European trade, calling it "prudent" at the time.

The European trade was initiated by Mr. Corzine late in the summer of 2010. The new chief executive explained the bet to a small group of top traders, arguing that Europe would not let its brethren default. In just a few months, the trade swelled to $6.3 billion, from $1.5 billion.

Europe's debt crisis, meanwhile, continued to flare, raising questions about whether some of the Continent's bigger economies, Spain and Italy, might be ensnared in the maelstrom.

In August, some directors questioned the chief executive, asking him to reduce the size of the position. Mr. Corzine calmly assured them they had little to fear.

"If you want a smaller or different position, maybe you don't have the right guy here," he told them, according to a person familiar with the matter. He also told one senior board member that he would "be willing to step down" if they "had lost confidence in me," Mr. Corzine told Congress on Thursday, although he said he had not intended to make a threat.

The board relented.

A Curious Career Move

Few would have guessed that Mr. Corzine, having led Goldman Sachs before serving in the Senate and as a governor of New Jersey, would wind up the chief executive of a little-known brokerage house.

At Goldman, which he joined in 1975, the young bond trader quickly gained a reputation as someone able to take big risks and generate big profits. Even after ascending to the top of the firm, he kept his own trading account to make bets with the firm's capital. In 1999, Mr. Corzine was ousted from Goldman amid a power struggle.

By 2010, having suffered a stinging defeat in his bid for re-election as the Democratic governor of New Jersey, Mr. Corzine hoped to resume his career on Wall Street.

A friend, J. Christopher Flowers, one of MF Global's largest investors, helped him get there. Mr. Corzine and Mr. Flowers worked at Goldman decades ago, and at one point, Mr. Flowers helped manage Mr. Corzine's vast wealth while he was a senator, according to Congressional records.

Mr. Corzine's arrival was a coup. MF Global had hired an executive search firm, Westwood Partners, to hunt for a new leader. But some members of the board, including David I. Schamis, who worked for Mr. Flowers, were recruiting Mr. Corzine.

He was a popular manager, former employees say. An avuncular presence with a beard and sweater vest, he had a knack for remembering names. Even in the firm's final hours, they recall that Mr. Corzine never lost his temper. His work ethic also impressed colleagues. He often started his day with a five-mile run, landing in the office by 6 a.m. and was regularly the last person to leave the office.

His intense routine was on par with his ambitions for the firm. With 15 top executives in the firm's boardroom on his first day, March 23, 2010, he said, "I think this firm has tremendous potential and I can't wait to get started," one person who attended said.

Mr. Corzine faced a steep challenge.

For years, MF Global aligned buyers and sellers of futures contracts for commodities like wheat or metals, and took a small commission along the way. But over the last decade, that business had become endangered. By the time Mr. Corzine arrived, near zero-percent interest rates and paper-thin commissions had led to five consecutive quarters of losses.

Soon after taking the helm, Mr. Corzine oversaw a wave of job cuts and overhauled compensation, moving from steady commissions to salary and discretionary bonuses like the rest of Wall Street.

At the same time, Mr. Corzine filled the ranks with employees from Goldman Sachs and hedge funds like the Soros Fund Management. He recruited Bradley Abelow, a fellow Goldman alumnus and a top aide when he was governor, to be chief operating officer.

Mr. Corzine arrived just as Washington was pressing the big banks to curb their lucrative yet risky businesses. Spotting an opening, he fashioned new trading desks, including one just for mortgage securities and a separate unit to trade using the firm's own capital, a business known as proprietary trading.

Not to be outdone, Mr. Corzine was the most profitable trader in that team, known as the Principal Strategies Group, according to a person briefed on the matter. Mr. Corzine traded oil, Treasury securities and currencies and earned in excess of $10 million for the firm in 2011, the person said.

Some inside MF Global worried that the expansion of the profitable trading business in New York came at the expense of its futures clearing operation, which was centered in Chicago. To drum up sales, Chicago brokers were pushed to introduce longtime clients to their counterparts in New York, a move that raised tensions.

At times, Mr. Corzine seemed unfamiliar with some aspects of the futures division. In June, speaking at the Sandler O'Neill Financial Services Conference at the St. Regis Hotel in Manhattan, Mr. Corzine stumbled. "Right now, if you thought about MF Global's retail business, you probably could only think of - ," he said, then paused to recall the name of the division at MF Global that catered to individual investors.

He leaned over to an aide, who told him it was Lind-Waldock.

'Chief Risk Officer'

"I consider one of my most important jobs to be chief risk officer of our firm," Mr. Corzine told that conference.

Yet soon after joining MF Global, Mr. Corzine torpedoed an effort to build a new risk system, a much-needed overhaul, according to former employees. (A person familiar with Mr. Corzine's thinking said that he saw the need to upgrade, but that the system being proposed was "unduly expensive" and was focused in part on things the firm didn't trade.)

While risk at the firm had been sharply increased with the bet on European sovereign debt, there was a compelling argument for Mr. Corzine's strategy.

MF Global had obtained loans to buy debt of Italy, Ireland and other troubled European nations, while simultaneously pledging the bonds as collateral to support the loans. The loans would come due when the bonds matured, which would happen no later than the end of 2012. MF Global, Mr. Corzine reckoned, would profit on the spread between the interest paid on the loans and the coupons earned from the bonds.

But the size of the European position was making the firm's top risk officers, Michael Roseman and Talha Chaudhry, increasingly uncomfortable by late 2010, according to people familiar with the situation. They pushed Mr. Corzine to seek approval from the board if he wanted to expand it.

Mr. Roseman then gave a PowerPoint presentation for board members, explaining the sovereign debt trade as Mr. Corzine sat a few feet away. The presentation made clear the risks, which hinged on the nations not defaulting or the bonds losing so much value they caused a cash squeeze. The directors approved the increase. Mr. Roseman eventually left the firm.

Within MF Global, Mr. Corzine welcomed discussion about his bet and his reasons for it, though some senior managers said they feared confronting such a prominent figure. Those who did challenge him recall making little progress. One senior trader said that each time he addressed his concerns, the chief executive would nod with understanding but do nothing.

These concerns were only internal at first because, while MF Global had disclosed the existence of the transactions in at least one filing in 2010, it never mentioned the extent to which they were used to finance the purchase of European debt.

The firm bought its European sovereign bonds making use of an arcane transaction known as repurchase-to-maturity. Repo-to-maturity allowed the company to classify the purchase of the bonds as a sale, rather than a risky bet subject to the whims of the market. That called to mind an earlier era of trading when firms used repo-to-maturity to finance the purchase of risk-free assets like United States Treasury securities, Mr. Corzine's specialty at Goldman many years earlier.

"It's like a bond trader from 15 years ago went to sleep and suddenly awoke to make these trades," one regulator who later reviewed the transactions remarked to a colleague.

Eventually, MF Global's auditor, PricewaterhouseCoopers, asked Mr. Corzine to report the European debt exposure to his investors. He personally met with the accounting firm in December 2010, two people said, and it was agreed that the transactions would be mentioned in a footnote in the firm's annual report, which was filed on May 20, 2011.

Earlier, one of MF Global's many regulators noticed something curious. The Financial Industry Regulatory Authority, which helped watch over MF Global's securities business, noticed a sharp swing in profits in a monthly report the firm filed to regulators. Finra asked MF Global executives about the volatile accounting line but did not get a satisfactory answer, say people familiar with the matter, until the annual report came out weeks later.

When Finra realized what MF Global was doing, it grew concerned. The Wall Street self-regulator told MF Global to set aside enough money in case the trades went bad. But Finra didn't have the authority to force the firm to do so - that power was in the hands of the Securities and Exchange Commission, whose rule Finra was citing.

Mr. Corzine then personally took the firm's case to the S.E.C. in mid-August, taking the Delta Shuttle to Washington for a meeting with a top agency official.

The S.E.C. indicated it would side with Finra, but needed a few weeks to make a final determination. In the meantime, MF Global and Finra haggled over the size of the capital cushion: the regulator wanted $200 million set aside, while the firm pushed for a figure closer to $50 million. In late August, Finra won out.

It would be the beginning of the end for MF Global.

The Unwinding

MF Global's investors may not have been fully informed about the European bet, but the firm's executives had been explaining the strategy to the ratings agencies for months, according to two people with direct knowledge of the conservations. Indeed, Moody's Investors Service and Standard & Poor's had applauded Mr. Corzine's effort to overhaul the firm, a move that included ratcheting up risk.

"We consider the most recent strategic plan of the new C.E.O. Jon Corzine to be sound," S.& P. said in 2010, while acknowledging the plan "will incrementally increase the firm's risk profile."

But the move by Finra to force the extra capital cushion appeared to only unnerve the ratings agencies when news reports about it emerged in October. A week later, Moody's cut its rating on MF Global to a notch above junk, pointing to the European debt holdings.

The reversal angered some executives at MF Global, who felt it was disingenuous for the agency to change its mind so suddenly. A spokesman for the ratings agency said, "Moody's does not refrain from taking rating action when its opinion on the credit risk of an issuer has changed."

The downgrade sent MF Global into free fall on Oct. 25. Its stock price plunged and trading partners and lenders demanded more capital to continue doing business with the company. At day's end, rattled employees dialed into a conference call with Mr. Corzine, who tried to be encouraging.

"The sun will come out tomorrow," he told them, according to one employee.

In truth, the company had just two options: sell itself or unload assets. Mr. Corzine organized two teams. Mr. Abelow, his deputy, began hunting for a buyer and decamped to the 40th floor of the firm's Midtown Manhattan headquarters. On the 39th floor, where his office was next to the trading floor, Mr. Corzine took charge of selling the assets.

On Friday evening, Oct. 28, regulators and top executives trooped into Mr. Corzine's office, joining a phone conference with Mary L. Schapiro, chairwoman of the S.E.C. Pictures of Mr. Corzine with Presidents Barack Obama and Bill Clinton sat on shelves near his desk. Towering stacks of paper lined the walls and windowsills of his modest office, partly obscuring the window view.

Dressed in his trademark sweater vest, Mr. Corzine expressed confidence a deal would be reached with one of the potential buyers, which included Interactive Brokers, JPMorgan Chase, the Jefferies Group and the Macquarie Group, according to people briefed on the call.

A deal became crucial as trading partners and lenders circled the firm. LCH.Clearnet, the firm responsible for clearing the vast majority of MF Global's European sovereign debt trades, was also demanding $200 million to maintain the positions, atop $100 million it had claimed from MF Global earlier in the week, one person briefed on the situation said.

Other people close to the investigation, led by the Commodity Futures Trading Commission's enforcement division, have said that as the firm rushed to pay off creditors, MF Global dipped again and again into customer funds to meet the demands.

The bidders dropped out one by one, leaving just Interactive Brokers on Sunday, Oct. 30. Mr. Corzine and his team briefed regulators at 2 p.m. saying a sale looked likely to go through. About nine hours later, he got word that more than $950 million in customer funds was missing, making a merger impossible. The day after the bankruptcy, Mr. Corzine sifted through transactions in the hope of locating the missing money, one person said.

Ultimately, the bets Corzine placed wound up better than the firm itself. The European debt trades were profitable, though too late for MF Global.

Before Congress on Thursday, Mr. Corzine continued to emphasize how well his trades held up. "As of today, none of the foreign debt securities that MF Global used," he said, "has defaulted or been restructured."

"There actually were no losses."

Kevin Roose and Lisa Schwartz contributed reporting.

[TFF] Models Behaving Badly Led to MF’s Global Collapse – People Too: Emanuel Derman ...

TFF — 11/21/2011 5:05:32 PM

Models Behaving Badly Led to MF’s Global Collapse – People Too: Emanuel Derman

"The entire system has been utterly destroyed by the MF Global collapse," Ann Barnhardt, founder and CEO of Barnhardt Capital Management, declared last week in a letter to clients.

Whether that's hyperbole or not is a matter of opinion, but MF Global's collapse — and the inability of investigators to find about $1.2 billion in "missing" customer funds, which is twice the amount previously thought — has only further undermined confidence among investors and market participants alike.

Emanuel Derman, a professor at Columbia University and former Goldman Sachs managing director, says MF Global was undone by an over-reliance on short-term funding, which dried up as revelations of its leveraged bets on European sovereign debt came to light.

In the accompanying video, Derman says MF Global was much more like Long Term Capital Management than Goldman Sachs, where he worked on the risk committee for then-CEO John Corzine.

A widely respected expert on risk management, Derman is the author of a new book Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life.

As discussed in the accompanying video, Derman says the "idolatry" of financial models puts Wall Street firms — if not the entire banking system — at risk of catastrophe. MFGlobal was an extreme example of what can happen when the models — and the people who run them -- behave badly, but if Barnhardt is even a little bit right, expect more casualties to emerge.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com

finance.yahoo.com

[TFF] SEC Approves CBOE Holdings' Proposal To Trade SPXpm , Launch Oct 4 ...

TFF — 9/24/2011 10:04:51 AM

SEC Approves CBOE Holdings' Proposal To Trade SPXpm , Launch Oct 4

ir.cboe.com

cboe.com

The contracts are CBOE's biggest source of profits, and the licensing agreement with S&P parent McGraw-Hill Cos. (MHP) underlies a new, electronic version of the product set to launch Oct. 4.