The joint report of the Commodity Futures Trading Commission and the Securities and Exchange Commission on the May 6 Flash Crash is out; and, as expected, the trigger event was found to be a large, programmed effort by a mutual fund complex to sell E-Mini contracts.
That complex is reported to be Waddell & Reed, a 73-year-old asset manager which has indicated it was engaged in normal trading activities and had no intent of affecting overall market direction.
Here’s the pertinent part of the report:
At 2:32 p.m., against this backdrop of unusually high volatility and thinning liquidity, a large fundamental trader (a mutual fund complex) initiated a sell program to sell a total of 75,000 E-Mini contracts (valued at approximately $4.1 billion) as a hedge to an existing equity position.
Generally, a customer has a number of alternatives as to how to execute a large trade. First, a customer may choose to engage an intermediary, who would, in turn, execute a block trade or manage the position. Second, a customer may choose to manually enter orders into the market. Third, a customer can execute a trade via an automated execution algorithm, which can meet the customer’s needs by taking price, time or volume into consideration. Effectively, a customer must make a choice as to how much human judgment is involved while executing a trade.
This large fundamental trader chose to execute this sell program via an automated execution algorithm ("Sell Algorithm") that was programmed to feed orders into the June 2010 E-Mini market to target an execution rate set to 9 percent of the trading volume calculated over the previous minute, but without regard to price or time.
The execution of this sell program resulted in the largest net change in daily position of any trader in the E-Mini since the beginning of the year (from January 1, 2010 through May 6, 2010). Only two single-day sell programs of equal or larger size – one of which was by the same large fundamental trader – were executed in the E-Mini in the 12 months prior to May 6. When executing the previous sell program, this large fundamental trader utilized a combination of manual trading entered over the course of a day and several automated execution algorithms which took into account price, time, and volume. On that occasion it took more than 5 hours for this large trader to execute the first 75,000 contracts of a large sell program.
However, on May 6, when markets were already under stress, the Sell Algorithm chosen by the large trader to only target trading volume, and neither price nor time, executed the sell program extremely rapidly in just 20 minutes. 7 3 May 6, 2010 Market Event Findings
This sell pressure was initially absorbed by: high frequency traders ("HFTs") and other intermediaries in the futures market; . fundamental buyers in the futures market; and
cross-market arbitrageurs who transferred this sell pressure to the equities markets by opportunistically buying E-Mini contracts and simultaneously selling products like SPY, or selling individual equities in the S&P 500 Index.
HFTs and intermediaries were the likely buyers of the initial batch of orders submitted by the Sell Algorithm, and, as a result, these buyers built up temporary long positions. Specifically, HFTs accumulated a net long position of about 3,300 contracts. However, between 2:41 p.m. and 2:44 p.m., HFTs aggressively sold about 2,000 E-Mini contracts in order to reduce their temporary long positions. At the same time, HFTs traded nearly 140,000 E-Mini contracts or over 33% of the total trading volume. This is consistent with the HFTs’ typical practice of trading a very large number of contracts, but not accumulating an aggregate inventory beyond three to four thousand contracts in either direction.
This story originally appeared in Securities Technology Monitor
