Dallas hedge fund suing over 'flash crash' losses

Discussion in 'Automated Trading' started by falcontrader, Dec 24, 2010.

  1. Blotto


    "Before markets opened on May 6, the GovPlus funds had sold some Standard & Poor's 500 index put options on the Chicago Board Options Exchange. When markets plummeted the afternoon of May 6, the funds were on the hook for potentially huge losses."

    So the fund, by free consent, takes exposure to both directional risk and volatility risk. It is the wrong way around on both. It was clear that the market was in a weak phase after the April 26 high. This was known in advance by all proficient market operators. A competent firm would not have been long equities and short gamma.

    "To limit their losses and comply with their risk management guidelines, they bought put options on the S&P 500 from Citadel, Wolverine and CTC. But the price of the options spiked during the crash from about 90 cents per contract to $30 per contract, a 3,233 percent increase, the lawsuit said. "

    Realising they got it wrong, and in all likelihood being so leveraged as to impact the stability of the funds, they chose again by free consent, to reduce their exposure. Citadel, Woverine, and CTC provided, by free consent, a valuable service to the Dallas fund - agreeing to take on their risk in return for a premium. The price was agreed by all parties. Further, had the markets come off another 10% in the following hour or day, Citiadel et al would be wearing the further losses, and the GovPlus funds would have been quite content with the deal.

    "Subsequently, U.S. exchanges canceled more than 20,000 trades in more than 300 equities and equity derivatives, in which prices changed by more than 60 percent during the flash crash, the lawsuit said. The Chicago Board Options Exchange only broke about 138 trades, it said."

    This is what makes trading in such markets bothersome. Reading the future flow is not the issue - the ex post facto actions of exchanges and courts is. One of my contacts knew a fixed income trader who went bust on a large spike in the German bond futures. He bought aggressively near the low of a spike, providing liquidity and helping to stabilise the market during a selloff. He sold at much higher prices later in the day when markets were trading in less volatile conditions. The following day, Eurex broke his buys but not his sells leaving him net short a large position from two handles lower (€2,000 per contract) and he was busted. The exchange margin on that product at the time was around €1,700 if I recall.

    I know the exchange rules and no bust ranges (where applicable) for the products I trade. All traders must make it their duty to understand the rules of the exchanges on which they trade. However, one must also be aware that this is an old boys club and rules can sometimes be adjusted etc when some particularly important interests have made an expensive error. This is just another risk of doing business. I am glad the CME did not break trades, although the market was extremely thin for a few minutes when the NYSE was unavailable. Anyone who had futures trades done during that would have had a nervous few hours waiting to hear from their clearing house if the exchange had broken any trades. Again, this wouldn't blow up a responsible operator, however it could set one back months to years depending.

    "During the flash crash, U.S. equities markets failed investors," the lawsuit said. "They gave the appearance that a historic fire was burning somewhere in the world causing the intrinsic value of U.S. bellwether equities to plummet. In reality, there was no fire anywhere, only a false alarm propagated without contemporaneous explanation across markets in minutes."

    No, investors were just fine. Investors are not bothered by one day moves or gains / losses of 10%. The market did not even close substantially down on the day. This is an incompetent (they got the future direction and volatility wrong - and ballsed up their risk management into the bargain), overleveraged (they were forced to puke on 10% move against their position), irresponsible fund (they now gamble client assets further on a hopeless lawsuit, which if it were successful would raise the risk and cost of doing business of the firm itself and every other market participant). Idiocy.

    As for all this rhetoric and nonsense about "historic fires" and "intrinsic value" - more immature rubbish - arguing with the markets and whining about making a bad bet rather than taking responsiblity. Ugh. Can we have some humility please. I wonder whether this suit is at the behest of misguided clients, or the same incompetent fund managers?

    Free markets do not "fail investors". Losses are a result of error. If you buy insurance at an agreed price do not complain later when the insured risk does not materialise and you consider the premium "wasted".

    I might add, if there was no "historic fire", why did the fund have to puke its positions? Why did they not wait for confirmed news of a natural disaster, world war, or something else which would have "justified" the prices (fundamentally speaking) before trading on them? Could it be because price is what matters, not woolly notions about fundamentals and value?

    In closing, that selloff was quite forseeable. Not the amount in one day, but the level we finally reached later in the year - this was the clear objective since the April high. I suspect the fund would have still been hurt on the positions had they held them further, however they paid the price for unwinding in a very illiquid and high volatility environment. I thought the events of late 2008 would be recent enough to cull such stupidity, but alas not.

    This culture upsets me greatly. There was a time when this was not the norm, quite the opposite. In finance especially, in the times when boots had laces and trousers had braces. Operators were required to behave in a mature, responsible manner befitting gentlemen, and to honour their voluntary commitments without complaint. This is a sad indictment of the industry indeed, one of many this last decade. Can any of the more experienced ladies and gentlemen here who have been members of an exchange imagine such nonsense being tolerated on a trading floor?

    Bloody welchers.

    Another thought occurs. Is this lawsuit even competent? Will the court accept jurisdiction? The trades were done on a regulated securities exchange, in compliance with the exchange rules, and the exchange has elected not to break the trades. Is there an arbitration agreement in force? I doubt the exchange will be best pleased with this course of action. What about the funds' clearers? Are there grounds for a counter suit. This needs to be stepped on sharpish. I would like judgement for the defendant with costs awarded and some strong language from the judge if it gets that far.

    Finally, the legal theory is absurd. I am not a practitioner but do not believe this constitutes unjust enrichment. I am off to look at the IL and Federal statutes. Commentary from anyone here with expertise would be interesting.
  2. may 6 the markets didn't fail 'investors'

    investors weren't even in the market.

    the exchanges have changed since versuse the 80's and even 90's befoe the exchange was a co-op of brokers coming together..now th exchange is a 'corporation' and brokers are customers..brokers no longer have any input to the exchange rules...

    if traders and investors dont' like the rules at the NYSE,nasdaq or any exchange the y can choose not to trade,invest orlis their company in US exchanges...listing and mainteance fees for small companies is the most expensive for US exchanges.....it cost like $100,000 just for a company to get listed in the OTCBB or nasdaq and even more for NYSE and not worth the administractive cost..i mean these exchanges are basically easy to operate it mainly just an exchange pushing electrons..it should cost that much just to advertise on teh exchange.

    as for hedge funds they are as good as individual participatns and know the rules...even though the rules are unfair and prone to abuse like mays 6 and frontrunning..

    traders and investors don't have to invest or trade in the exchanges.

    traders and investors can choose not to participate if they don't like rules.

    who needs the SEC anymore.

    without the brokeres and traders and hedge funds there is no need for the exchagne...all the traderse and brokers can form their own exchange and boycott exhanges that have bad rules or no rules or rules that anren't enforced...the problem is the SEC regulates the financial sector...and the regulations benefit a few powerful interest groups who own the exhange or some large firms or banks who control the exhange.
  3. the hedge fund should read the fine print when they opened the account at the exchange.

    don't like rules, get out of the building.

    the exchange is not liable for any market problems the exhange is just a 'venue' for market partiicipants to trade....the exchange is all about making money these days.

    the exchange really doesn't care about rules or fair orderly markets anymore or free markets anymore.

    or don't care about market integrity...which is why it's market particiapants beware..

    the market in the OTCBB and pinksheets have sam market integrity as nasdaq and NYSE...penny stocks in the OTCBB and pinksheets have more market integrity than NYSE stocks or nasdaq stocks. and even the the CME..these exchanges don't care about market integrity all they care about is making money. exchanges aer now 'corporations' and no longer non-profit co-ops anymore.

    when the exchanges were non-profit or member owned co-ops the rules were made by the members(brokers) not by the SEC or managemetn of some corporation or one large customer of the exchange.
  4. Wouldn't this go to some sort of arbitrator. I believe this is
    way it is with trading.
  5. I agree that exchanges should have stayed non profit for the
    maximum benefit of the market participants.
  6. the1


    Boy, I dunno. Seems this Hedge Fund doesn't understand the concept of Systemic Risk. Why isn't Waddel and Reed named in the suit for selling 75,000 S&P500 futures contracts, if that's really what those naughty boys did?

    I got wacked in that flash crash as well. Who do I get to sue? No one. I had to lick my wounds and move on. I doubt this suit gets far but obviously I don't know all the facts based on the limited information in that article.
  7. Eddiefl