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November 1, 2010

Trading Collars Not Coming Soon

By John D'Antona Jr.

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  • Trading Collars Not Coming Soon
  • Page 2

Traders are going to have to get used to the single-stock circuit breakers put into effect shortly after the May 6 flash crash, because any replacement is still on the drawing board.

Shane Swanson

While the single-stock circuit breakers--SSCBs--have been praised for being easy to implement and for their effectiveness at slowing rapidly rising or falling securities, they have been criticized for going off too regularly.

Relatively small erroneous prints have been triggering five-minute trading halts in such actively traded names as Citigroup, much to the woe of traders. Trading executives have touted so-called collars, or price bands, as superior substitutes, but there is still much debate over how to incorporate them.

Exchange executives at first predicted rapid implementation of an alternative to SSCBs, but now brokerages are weighing in with concerns and ideas. The back-and-forth means implementation by early 2011, as predicted, is unlikely.

"I think we have a long way to go before we end up with a rule," Shane Swanson said at the Futures Industry Association/Options Industry Conference on Oct. 5 in New York. "And then whatever that rule is, I think we have a long way to go before we actually implement it."

A limit up/limit down, or price band, mechanism is used in the futures market. It limits trades to prices around a given reference price, such as the previous day's close. Trades inside the band are allowed; those outside the band are rejected.

This is in stark contrast to how SSCBs operate in the equities market. They stop exchange trading altogether for any stock in the S&P 500 index, Russell 1000 index and select exchange-traded funds that moves by at least 10 percent in a five-minute period.

Most in the market agree that a remedy to the current circuit breakers is needed. Proponents of limit up/limit down, such as the exchanges, point out that it prevents erroneous trades from occurring, such as on May 6, when around 20,000 such trades were canceled. Limits would reject all orders posted outside the price band. In addition, limit up/limit down would keep the markets open and let trading and price discovery continue.

Still, some in the industry see a role for both circuit breakers and price bands. In an Oct. 12 comment letter to the Securities and Exchange Commission, the Securities Industry and Financial Markets Association advocated a hybrid mechanism. It would contain three key elements: limit up/limit down, a request for liquidity and, where necessary, trading halts.

Price bands would prevent trades from occurring outside acceptable predetermined price ranges. These ranges would be calculated and broadcast to all market participants on a periodic intraday basis.

A bid/offer wanted period would establish a mechanism for alerting market participants to the need for additional liquidity within the acceptable price range to avoid unnecessary price swings.