We donât like to gloat, but err, in this case we canât help ourselves. Thatâs because from the moment commodity ETFs like the USO and the UNG began acting weirdly in 2009, FT Alphaville speculated they were probably being arbitraged in some fancy fashion by a new breed of index arbitrageur, who had shrewdly spotted a fresh cross-asset opportunity. This week it transpired that algorithmic arbitrage versus an oil ETF (the USO no less) was in fact behind Februaryâs abrupt market moves â initially suspected to be connected to a liquidation by the Blue Gold fund. As Reuters noted, having dug up the details of the chaos-causing algorithms: Infinium, a household name in Chicagoâs burgeoning trading community, relies on computer horsepower and quantitative models to earn razor-thin profits from short-term trading. It uses its own money to make markets and capitalize on tiny imbalances, a common high-frequency strategy. The documents, dated March, reveal that Infinium used an algorithm that was less than a day old to execute a âlead/lagâ strategy between an exchange-traded fund called United States Oil Fund (USO.P: Quote), which tracks oil prices, and the U.S. crude benchmark future, West Texas Intermediate CLc1. The algorithm was turned on at 2:26:28 p.m. (Eastern) on Feb. 3, less than four minutes before NYMEX closed floor trading and settled oil prices. It immediately started uncontrollably buying oil futures, according to the documents, which include letters from Infiniumâs lawyer to the regulation unit of CME Group, and cite notes from a company developer. Infinium placed 2,000 to 3,000 orders per second before its flooded order router âchokedâ and was âdead in the waterâ a few seconds later, the developerâs notes said. The algorithm was shut down five seconds after it was turned on. By then, the documents show, the firm had sent 4,612 âbuy limitâ orders into the market. It quickly offset the position, mostly with large âblockâ trades in the next few minutes, leaving it with a $1.03-million loss. Fascinating stuff. But if anything, Infinium Capital is possibly a new entrant to the ETF commodity/underlying arbitrage game. A few more seasoned participants â which the mainstream media still hasnât caught up on in detail â are EWT LLC, a subsidiary of Madison Tyler Holdings, which specialises in cross-asset arbitrage and happens to be a company with very interesting connections; and also high-frequency market-making power house Susquehanna International Group (SIG). We might add that according to SIGâs latest 13F SEC holdings filing, the group was an owner of every single ETF featured in the 20 most cancelled securities on flash crash day. It was also a holder of Accenture and Procter & Gamble shares too â both of which featured prominently in the crash as well. Itâs quite a fascinating and uber-secretive firm in its own right too. Other HFT firms âmarket makersâ worth checking out â all of whom have big positions in ETFs and commodity futures too â are Jane Street Holding, a quantitative proprietary trading firm; IMC-Chicago, which specialises in liquidity provision and algorithmic arbitrage; First New York Securities, which had a very sizeable position in UNG; and last but not least, new start-up Five Rings Capital. As for Dutch high-frequency market maker Optiver, another big player in commodity ETFs, theyâre already being investigated by the CFTC for allegedly âbanging the closeâ through trade at settlement contracts on the Nymex. The WSJ has also already reported that both Morgan Stanley and UBS â two big ETF market makers â settled CFTC charges concerning their trading of crude-oil futures on the day that the USO fund was shifting out of a contract ahead of its expiration earlier in the year too. And just in case you thought such antics were purely restricted to commodity ETFs, in reality the fast-paced strategies can be migrated anywhere thereâs an arbitrage between an exchange-traded future and an exchange-traded fund to be had. (Itâs all the more fruitful, by the way, if the ETF is actually based on an index derived from futures prices in the first place.) http://ftalphaville.ft.com/blog/2010/08/27/328631/etfs-and-hft-redux/ Very, very interesting article. You have to check the links within the FTAlphaville article, too.