The Myth of One Bad Trade

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IndexUniverse submits:

By Dave Nadig

Stories everywhere are blaming last Thursday's crazy sell-off on 'one bad trade' in Procter & Gamble ( PG ). Bullpucky!

Sure, P&G would a be big story. But it's also the wrong story.

Here's a common take on the matter:

"According to multiple sources, a trader entered a "b" for billion instead of an "m" for million in a trade possibly involving Procter & Gamble, a component in the Dow."

First off, let's be clear: P&G may have had a bad day, but compared with other equities-ETFs, mostly-P&G had a fine time of it. At the end of it all, exactly six P&G trades were canceled on May 6, and not one of them is aberrant. Every one of them was over $60, a perfectly healthy price for the stock. They're just run-of-the-mill broken trades.

On the other extreme, the Rydex S&P Equal Weight ETF ( RSP ) had 2,098 canceled trades in a time window of just a few minutes.

It's easy to understand the confusion-hundreds of securities were affected during the brief episode of insanity that started around 2:45 p.m. last Thursday. Hundreds of thousands of trades are out there to be analyzed, but it's blisteringly clear that P&G had little to do with it. The timing's just wrong.

For your consideration, here's a scatter chart of every trade in P&G between 2:45 and 2:48 p.m., with every trade in RSP for the same period. Scatter charts are really the only good way to interpret tick data, because in some cases we're dealing with hundreds of trades a second and, most of the time, analyzing canceled trades alongside viable trades is highly problematic.

RSP vs. Procter & Gamble

That plummeting line in RSP at 2:45:36 is, in my research so far, the best guess on the "when-did-it-start" question. I'm also sure that if I had the time to go through the tape for all 281 Nasdaq-listed securities with canceled trades, I'd probably find an earlier example. Note that what's not on the RSP chart are the 2,000 or so cancelled trades all crossing at a penny or below. Only the good trades are showing.

It's also clear to me that this is program trading. Thousands of 100-share trades at an absurd price (for the seller at least) don't happen on purpose. They happen by mistake. Nobody intended to rationally sell RSP for a thousandth-of-a-penny-a price at which the entire U.S. stock market could have been exchanged for a Gulfstream jet.

It's been documented in many places that many of the larger trading houses stepped away when things got too weird, and that the lack of these big liquidity traders, serving as de facto market makers, made matters much worse.

I'll add a supposition of my own. The arbitrage that exists between ETFs and other ways of capturing the market (options, futures and underlying stocks) exists for everyone to capture, not just for authorized participants (APs).) APs have privileged access to one mechanism-buying and selling underlying shares directly with the ETF issuer-but anyone can try and profit from breakdowns in pricing mechanisms. And the actual dollar value of the trades in question-at or below a penny-is miniscule, or $30,000 in the case of RSP.

Clearly technical errors occurred. But those technical errors could have been as innocent as an idiot incorrectly programming his desktop quant model and floating ask after ask into the market at an absurd price. The arbitrage present in ETFs is incredibly well documented and easily accessed. And it's easiest to access outside the boundaries of massively liquid ETFs such as [[QQQQ]] and [[SPY]].

That's why I think ETFs are at the center of last Thursday's action, and that's why I think so many smaller ETFs seem to be involved.

Original post

See also A Premium Options Trade With SPY on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , ETFs , Stocks

Referenced Stocks: PG , QQQ , RSP , SPY



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