Commodities and Alternative Investments - Session 10 - Slides

Course:
COMMODITIES AND
ALTERNATIVE INVESTMENTS
Course Instructor: Umang Somani, CAIA ([email protected])
Session 10: Flash Crash of 2010

1
What is a Flash Crash?
• A flash crash refers to rapid price declines in a market or a stock's price, due
to a withdrawal of orders, but then that quickly recovers, usually within the
same trading day.
• The biggest drop in Dow Jones Industrial Average (DJIA) history occurred on
May 6, 2010, after a flash crash wiped off trillions of dollars in equity.
• High-frequency trading firms are said to be largely responsible for flash

crashes in recent times.
2
Some examples
• 2010 Dow Flash Crash
• 2013 and Other NASDAQ Flash Crashes
• 2014 Bond Flash Crash
• 2015 NYSE Flash Crash
3
Flash Crash of 2010
4
What happened?
• The May 6, 2010, flash crash also known as the crash of 2:45 or simply the
flash crash, was a United States trillion-dollar stock market crash, which
started at 2:32 p.m. EDT and lasted for approximately 36 minutes.
• U.S. stock markets opened and the Dow was down, and trended that way for
most of the day on worries about the debt crisis in Greece.
• At 2:42 p.m., with the Dow down more than 300 points for the day, the
equity market began to fall rapidly, dropping an additional 600 points in 5
minutes for a loss of nearly 1,000 points for the day by 2:47 p.m.
• Twenty minutes later, by 3:07 p.m., the market had regained most of the
600-point drop.
5
May 6, 2010
6
Plausible theories to explain this plunge
7
Plausible theories to explain this Plunge
• The Fat-finger theory
• Impact from High Frequency traders
• Large Directional Bets
• Technical Glitches
8
Understanding some common trading terminologies
• A limit order is an order to buy or sell

a stock with a restriction on the
maximum price to be paid or the
minimum price to be received (the
“limit price”).
• A trader who wants to purchase (or sell) the stock as quickly as possible
would place a market order.
• A trader who wants to buy the stock when it dropped to $133 would place
a buy limit order with a limit price of $133 (green line).
• A trader who wants to sell the stock when it reached $142 would place a sell
limit order with a limit price of $142 (red line). 9
Understanding some common trading terminologies
• The term "bid" refers to the highest price a buyer

will pay to buy a specified number of shares of a
stock at any given time.
• The term "ask" refers to the lowest price at which a

seller will sell the stock.
• The bid price will almost always be lower than the

ask price.
• The difference between the bid price and the ask

price is called the "spread."
10

11
The fat-finger theory
• In 2010 immediately after the plunge, several reports indicated that the
event may have been triggered by a fat-finger trade, an inadvertent large
"sell order" for Procter & Gamble stock, inciting massive algorithmic
trading orders to dump the stock;
• However, this theory was quickly disproved after it was determined that
Procter and Gamble's decline occurred after a significant decline in the E-
Mini S&P 500 futures contracts.
12

13
Impact of high frequency traders
• Regulators found that high frequency traders exacerbated price declines.
• Regulators determined that high frequency traders sold aggressively to

eliminate their positions and withdrew from the markets in the face of
uncertainty.
• On September 3, 2010, the regulators probing the crash concluded: "that

quote-stuffing (placing and then almost immediately cancelling large
numbers of rapid-fire orders to buy or sell stocks) was not a 'major factor'
in the turmoil".
• Some have put forth the theory that high-frequency trading was actually a
major factor in minimizing and reversing the flash crash.
14

15
Large directional bets
• Regulators said a large E-Mini S&P 500 seller set off a chain of events
triggering the Flash Crash, but did not identify the firm.
• Earlier, some investigators suggested that a large purchase of put options

on the S&P 500 index by the hedge fund Universal Investments shortly
before the crash may have been among the primary causes.
• Other reports have speculated that the event may have been triggered by
a single sale of 75,000 E-Mini S&P 500 contracts valued at around $4
billion by Waddell & Reed on the Chicago Mercantile Exchange.
16

17
Technical Glitches
• An analysis of trading on the exchanges during the moments immediately

prior to the flash crash reveals technical glitches in the reporting of prices
on the NYSE and at the same time, there were errors in the prices of some
stocks (e.g., Apple Inc. and HP).
• Confused and uncertain about prices, many market participants

attempted to drop out of the market by posting stub quotes (very low bids
and very high offers) and, at the same time, many high-frequency trading
algorithms attempted to exit the market with market orders (which were
executed at the stub quotes) leading to a domino effect that resulted in
the flash crash plunge.
18
Technical Glitches
• All stocks were affected, but some radically so.

o Exelon Corp (EXC) traded at $0.00; it opened at $43.35 and closed the
day at $41.86.
o Accenture (ACN) opened at $41.94, hit $0.00, then closed at $41.09.
o Impax Laboratories (IPXL) opened at $18.48, went to $0.00, then closed
at $17.78.
o In a strange twist, Sotheby’s (BID) opened at $34.61, hit $100,000, and
closed at $33.
19
These theories sounds great, but who was held
responsible?
20
Spoofing Algorithm
• Spoofing refers to attempts by traders to influence market prices by

entering large orders with no expectation to executing the orders.
• As the orders began to impact the futures markets, other traders rapidly
joined in to sell futures contracts
• Within minutes, arbitrageurs began selling equities in the spot market

pushing the spot market down.
• In April 2015, Navinder Singh Sarao, a London-based point-and-click

trader, was arrested for his alleged role in the flash crash.
21
Spoofing Algorithm
• According to criminal charges brought by the United States Department of
Justice, Sarao allegedly used an automated program to generate large sell
orders, pushing down prices, which he then cancelled to buy at the lower
market prices.
• In August 2015, Sarao was released on a £50,000 bail with a full extradition
hearing scheduled for September with the US Department of Justice.
• Sarao and his company, Nav Sarao Futures Limited, allegedly made more
than $40 million in profit from trading from 2009 to 2015.
• Regulatory authorities in the U.S. have taken rapid steps, such as installing
circuit breakers and banning direct access to exchanges, to prevent flash
crashes. 22
Questions?
23

Commodities and Alternative Investments - Session 10 - Slides

Uploaded by

Copyright:

Available Formats

Commodities and Alternative Investments - Session 10 - Slides

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Commodities and Alternative Investments - Session 10 - Slides

Uploaded by

Copyright:

Available Formats

Course:

Session 10: Flash Crash of 2010

• High-frequency trading firms are said to be largely responsible for flash

• 2010 Dow Flash Crash

• 2013 and Other NASDAQ Flash Crashes

• 2014 Bond Flash Crash

• 2015 NYSE Flash Crash

• The Fat-finger theory

• Impact from High Frequency traders

• Large Directional Bets

• A limit order is an order to buy or sell

• The term "bid" refers to the highest price a buyer

• The term "ask" refers to the lowest price at which a

• The bid price will almost always be lower than the

• The difference between the bid price and the ask

• The Fat-finger theory

• The Fat-finger theory

• Regulators found that high frequency traders exacerbated price declines.

• Regulators determined that high frequency traders sold aggressively to

• On September 3, 2010, the regulators probing the crash concluded: "that

• The Fat-finger theory

• Earlier, some investigators suggested that a large purchase of put options

• The Fat-finger theory

• An analysis of trading on the exchanges during the moments immediately

• Confused and uncertain about prices, many market participants

• All stocks were affected, but some radically so.

• Spoofing refers to attempts by traders to influence market prices by

• Within minutes, arbitrageurs began selling equities in the spot market

• In April 2015, Navinder Singh Sarao, a London-based point-and-click

You might also like