Preliminary Report On ‘Flash Crash’ Links ETFs And E-Mini Futures

May 20, 2010

Was the May 6 ‘flash crash’ really just a perfect storm of abnormal trading activity in three different types of products?

The “flash crash” in U.S. financial markets on May 6 might have involved a link between stock index futures, ETFs and individual stocks, according to a preliminary report issued this week by the Securities and Exchange Commission and the Commodity Futures Trading Commission.

The report said that while plenty of negative sentiment was coursing through markets that day, largely connected to Greece’s fiscal crisis and civil unrest, something altogether different took hold during the episode that began shortly after 2:30 p.m. EDT and ended by 3 p.m. U.S. stocks fell almost 10 percent before whipsawing back upward to close 3.2 percent lower on the day.

The joint SEC-CFTC panel conjectured that the rapid decline in widely held index-linked products such as E-Mini S&P 500 futures and index ETFs, along with heavy selling in some individual securities, may have created a feedback loop that helped create the unprecedented swiftness and sharpness of the market movements that day.

According to the 151-page report, ETFs accounted for about 70 percent of the U.S.-listed securities whose trades were canceled in the wake of the May 6 session. The New York Stock Exchange and Nasdaq voided trades in any security that posted a decline of 60 percent or more from its 2:40 p.m. EDT price. The joint panel is continuing to investigate why ETFs were disproportionately affected on that day.

Additionally, the joint panel pointed to a lack of coordination between different exchanges, a concern shared by various market sources in the aftermath of the flash crash. For example, the NYSE slowed trade down while other exchanges kept up the trade, causing a bottleneck of electronic sell orders that many say helped the market lurch downward.

‘Fat Finger’ Downplayed

The study downplayed the possibility that a so-called fat-finger accident, involving an errant trader placing a huge sell order, was the trigger, and was similarly reluctant to blame either a terrorist act or computer hacking. But it did not definitively rule out any of those possibilities.

The report also raised the possibility that the combined effect of individual investors’ stop-loss orders, high-volume institutional selling and the inability of market makers and authorized participants to hedge their ETF positions may have combined to create liquidity problems and steep price declines.

Regulators are focusing on the equity market because bond-linked ETFs generally didn’t display the same kind of volatility as their stock-based counterparts.


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