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A couple of days ago, a futures trader from London, England was arrested for manipulating the E-mini S&P 500 contract. It made big headlines because the CFTC claimed the trader’s actions directly contributed to the 2010 “flash crash.” In the charging documents, the CFTC asserted:

In addition to the Layering Algorithm, Defendants aggressively utilized the 188/289-Lot Spoofing which intensified the Layering Algorithm’s effects. Between 12:33 p.m. CT -1:45 p.m. CT, Defendants placed a total of 135 orders with 188 or 289 lots on the sell-side of the Order Book, totaling 32,046 contracts. Ofthese 135 188/289-lot orders, 132 orders were canceled without resulting in execution.

Between 11:17 a.m. CT and 1:40 p.m. CT, Defendants’ actions contributed to an extreme order book imbalance in the E-mini S&P market. This order book imbalance contributed to market conditions that caused theE-mini S&P price to fall361 basis points.

Who is this evil mastermind responsible for the terrible flash crash? Why none other than Navinder Singh Sarao, working out of his parent’s basement in Hounslow, a suburb in the West end of London.

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Like all good Evil Villains (a Keyser Söze of the futures villain trading world if we may call him that), there are few images of Nav Sarao. Here is one of the few available pictures of him, a sketch from his brief appearance in court.

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Now you may detect a little sarcasm in my depiction of Nav as the evil mastermind behind the 2010 flash crash. But don’t mistake that sarcasm as my condoning his actions. I think that his “spoofing” (posting orders in the book that have no intention of being filled) is pathetic. It ruins the integrity of the market, and is a complete nuisance. His continual booking, cancelling, rebooking, and cancelling ate up valuable computing cycles on the exchange’s server. And for what? So he could “fool” some traders into thinking the market was heavier than it actually was?

Nav’s behaviour was punishable and he definitely should not be allowed to trade. Yet for the government to claim that his actions contributed to the flash crash is even more pathetic. There is no way that Nav’s actions, as the government described them in the filing, were responsible for the flash crash in any way.

Let’s stop and think about the effect layering some extra sell orders into the book has on the marketplace. Yes, at the margin it causes some market participants to either take out short positions or accelerate the selling of their long positions. But do you think his trading caused big pension funds and other large institutions to change their trading one iota? Not a chance. Do you think that a portfolio manager is going to ever say the following:

Oh, I was going to buy 10,000 S&Ps throughout the day, and I was counting on putting it into CS First Boston’s VWAP server, but I see a persistent 188 lot sell order on the offer 3 levels up… I better cancel my order and change it to a sell.

I have executed real orders, from real institutions that move the market for days on end, and trust me, they don’t give a rats ass what some futures day trader sitting in his pyjamas in West London is doing with his persistent “sell up above but cancel if it gets close” algorithm.

Even the other locals that Nav might have fooled the first time will quickly learn to ignore that order. When the news of his arrest hit the tape, my twitter feed was filled with comments from other professional traders asking when the government would get around to arresting the perpetrators of the consistent spoofing that happens in a wide array of other markets.

This spoofing practice is annoying and practitioners should be prosecuted (although I think a better solution is either to charge a nominal fee every time you put in an order, or have a minimum one second holding period before they are cancellable). But I think the practice of front running real orders by HFTs is way more detrimental to the marketplace than spoofing. When you spoof, you are just wasting everyone’s time. When the HFT’s sense a big marketable order and proceed to beat the original order to the resting liquidity at the various other market venues, they are in essence imposing a tax. They are stealing liquidity and then re-offering it higher. That should be criminal, yet this is what HFT firms do all day long.

Instead of prosecuting this transactional tax imposed by the HFTs (or at the very least instituting rules to level the playing field), the CFTC is instead trying to blame the 2010 flash crash on some idiot futures day trader who was dumb (and arrogant) enough to engage in some of the stupidest strategies known to man.

At the end of the day, Nav did not cause the flash crash. The market was weak that day, and unless he took a naked short position of ten of thousands of contracts in a manipulative pile drive, then he is not responsible at all. Did he break the rules? Yes, and he should be punished. But the CFTC blaming him for the 2010 flash crash is even dumber than his trying to spoof a big liquid market like the S&P 500 futures contract.


The Gross Bottom?

Does the old man still have the touch? Did Bill Gross actually nail the bottom in German Bund yields almost to the hour?

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Yesterday things got squirrelly in the German bund square as there was a massive reversal from the seemingly never ending trend of lower rates. Before you could blink, the 10 year bund yield had gone from 0.09% to 0.16%.

I hate it when people use percentage moves in changes in yields at these low levels to describe “largest one day percentage move in bund yields ever.” Moving from 0.09% to 0.16% is a lot different than moving from 0.90% to 1.60%. Yet even discounting the hype, it was an important day. The fever seems to have broken, and now the question is; was this simply all the macro tourists jumping on Bill’s trade recommendation? Or does the market smell a deal coming from Greece, with a corresponding uptick in the European economy? I am betting on the latter…


The US Treasury curve has been quietly steepening

One of my non-consensus (and so far, just plain wrong) calls is that during this recovery the US treasury curve will steepen far more than during previous cycles. I believe that the Fed is going to be extremely slow at raising rates, and the long end of the curve is going to lose patience. And not only, I don’t think the Fed will be upset with that outcome.

Yet for the last year and a half, the curve has done nothing except flatten. The 5/30 treasury yield spread has gone from 250 basis points in the winter of 2013, to just a tad over 100 basis points a month ago.

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Don’t look now, but the curve has been quietly steepening over the past couple of weeks. I think the bond market is starting to anticipate the end of the recent US soft patch of economic data. It’s a fairly small move so far, but it looks like it might be poised to head higher in the coming weeks.

Thanks for reading,

Kevin Muir

the Macro Tourist