Nanex Research

Nanex ~ 26-Dec-2012 ~ Orchestrating Chaos

On December 26, 2012 at 11:02:59, the market suddenly exploded with activity (SPY dropped below 141.88 - a low set 12 days earlier on December 14). Approximately 3,800 March 2013 eMiini futures contracts (S$P 500) were sold during that second. We thought the sudden explosion in activity warranted a closer look.

What we found was fascinating. It appears the entire market-wide move may have been carefully orchestrated. One thing for certain is that our regulators will never be able to see the big picture if their analysis tools (MIDAS) only looks at equity data. Analyzing price moves in futures and options is crucial to understanding market-wide moves in equities, and visa versa.

Basically, this momentum ignition strategy is based on several principles.
  1. When the markets suddenly move, spreads immediately widen, and momentum based strategies will follow along in the same direction. Which means you will have built in buyers(sellers) to trade out of your position.
  2. When a stock's NBBO (national best bid/offer) is about to shift to a new price level (down in this example), the last buy orders at the old high bid price are the least desirable, and it is advantageous to execute against those bid prices. Furthermore it is an advantage to be first in the queue with sell orders at the new lower priced ask.

    For example, lets say the bid is $100 and the ask is $100.01, and it is about to change to a bid of $99.99 and ask of $100. The ask becomes the previous bid. Executing the last remaining buy orders at $100 will allow you to resell at the new ask price of $100 and capture a rebate (which could offset the taker fee for executing against the $100 bids).

    Stocks (e.g. MSFT, CSCO, BAC, JPM, AAPL) that are members of big ETFs (e.g. SPY, IWM and QQQ) will generally follow along with price changes in those ETFs, and these ETFs in turn are greatly influenced by trading in eMini futures (e.g. ES, TF, YM). When the price of the futures or ETFs suddenly drops, the NBBO's of many large cap stocks will shift to a new price level. The same thing will happen to options on the stocks and ETFs.
  3. Speed of light means information doesn't travel instantly. Stocks trade in New York and eMini futures trade in Chicago. These two locations are about 800 miles or 5 milliseconds apart. Which means machines trading in NY won't know what happens in Chicago for 5ms and machines trading in Chicago won't know what happens in NY for 5ms. This means that arbitrage based strategies are always behind by at least 5ms and therefore become another group that will buy[sell] from you when you exit your position.
  4. When market activity explodes, exchange matching engines will get out of synch on a very short term basis. Same with data feeds. Futures may get delayed vs. equities, or vice versa.
The basic strategy is (these events occur over just a few milliseconds of time):
  1. Execute against all but a few remaining buy[sell] orders at the prevailing bid[ask] price in MSFT, CSCO, BAC, JPM, AAPL and other stocks that move with SPY.
  2. Buy put[call] options and sell call[put] options on these stocks and ETFs.
  3. Prepare to place sell[buy] orders at the old bid[ask] price so that you are first in line.
  4. When all but the last few buy[sell] orders in your set of stocks remains, execute against them, and simultaneously sell[buy] SPY in NY and ES futures in Chicago. This will take a few $100 million in capital.
  5. Once the market is moving in your direction (which begins immediately when you sell[buy] SPY and ES), start trading out of the position. Because many systems are at various states of overload, you can use this to rapidly oscillate prices in futures and ETFs and fill momentum following HFT algorithms. See charts here for an extreme example that illustrates these oscillations.
Momentum ignition events happen all the time. See this page more details, including an animation that shows where and when these events have occurred since 2007.

December 26, 2012 at 11:02:59

Now let's take an a real-world example that happened on December 26, 2012 at 11:02:59. We'll start by comparing 4 charts: SPY, ES.H13, all NMS Equity Trades and all Option Trades, for one second of time beginning at 11:02:58.600.
   

From the charts above, it is not clear whether the activity started with ES.H13, so we'll zoom in on 135 milliseconds of time, starting at 11:02:59.360

   

From the charts above, it looks like activity started in ES.H13 at 11:02:59.420, and in SPY about 4 milliseconds later. But chart 3 shows activity in some NMS stocks also at 11:02:59.420. It takes about 5 milliseconds for information to travel between NY (where stock and options trade) and Chicago (where the emini futures trades). The timestamps are from the exchanges, so it's possible they might not be perfectly synchronized, though there's no excuse for that in today's high frequency trading world. One millisecond is 1,000 microseconds.

Let's look closer at the chart of all NMS Stock Trades.

All NMS Stock Trades - 1 millisecond interval chart showing trades color coded by exchange. Chart shows 200 milliseconds of time.
Some of the active, known symbols have been labelled. Note many large cap stocks show activity starting the same time as the eMini. Also note how SPY, IWM, and QQQ are the last ones with trades. You don't want to tip anyone off that activity is about to explode.

Now let's look closer at the final drop, by zooming in on 135 milliseconds of time, starting at 11:02:59.450


   

Circling back to the first chart, when we looked closer at SPY for a 25 millisecond period of time beginning at 11:02:59.424, we noticed something interesting. Note the trades from EDGX (blue diamonds). Now let's take a closer look in the chart below.

In the chart below, we show bids and asks from a few exchanges to remove clutter. Here, we show just EDGX (blue), BATS (pink) and ARCA (red). Here is a link to Excel Spreadsheet of all SPY trades and quotes between 11:02:59.424 to 11:02:59.450  This spreadsheet shows just updates to EDGX trades and quotes and is sequenced in the order they likely occurred.

From the spreadsheet and/or the chart below: the bid from EDGE remains at 141.93 and we see several quote updates from EDGX that don't change the bid or ask price or size. These appear to be generated after a trade executes at EDGX at 141.93 (but the trades get reported late, so they aren't in sequence with these EDGX quote updates). You need to keep the price from dropping until the last possible moment: surprise is key.

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