Goldman Gets a Do Over
- Posted by Jeff Carter
- on August 22nd, 2013
The botched trades occurred when Goldman’s internal computer system that helps to determine where to price options mistakenly ended up sending orders at errant prices. Goldman is a market maker in the options market.
Based on what little I know, I think it’s incorrect to bust the trades. My guess is that because Goldman does so much business at the various options exchanges, they threatened to pull their business or else.
One of the reasons that Goldman has the power to do this is the regulatory structure of the SEC. The SEC side of the market is so fragmented when it comes to single stocks and ETFs that Goldman could in fact probably pull a lot of its business away from listed markets on exchanges.
The US needs to go to central limit order books, end pay for order flow, internalization and other distortionary regulatory policy. That would help limit the market power one firm has over the rest of the market.
Thomas Peterffy, the entrepreneur behind Interactive Brokers said it best. There are firms and people on the opposite sides of those trades. What about them?
Busting the trades takes money out of the counterparty’s pockets. They had resting bid/offers in markets and were ready willing and able to assume the risks that corresponded to those bids/offers.
The other thing to remember is when a trade happens, it’s not an isolated instance. A cascade of ancillary trades happen in other options, other stocks or indexes, or other markets. If Goldman gets to cancel their trades, do the counter parties get to cancel all the cascading trades that were made? If so, do the cascading trades that were made because of those trades get the “do over” treatment?
The best example I can give you of a similar situation in a far different time happened when I was helping a trader arb between the Eurodollar Option pit at CME ($CME) and the same pit at LIFFE ($NYX) in 1986.
CRT was quoting prices in the LIFFE pit that were significantly higher than the same prices in the CME pit. They had incorrectly input the volatility into their computer program, so when the tear sheets spit out the prices were all wrong. I recall they were trading at a 20% volatility, when the rest of the world was trading at 14%.
That lasted for around a half an hour.
We sold them as much as they would buy, and arbed it off in the CME pit. CRT figured out they had an error, and ate it.
In my own career, I have made errors inputing trades into a computer. It’s called a fat finger. I bet I have lost well over $100k on fat finger errors. I never got a do over.
In the trading pit, I made errors. I never got a do over. I ate them.
Exchanges run their own businesses. They make business decisions, and clearly, they thought placating Goldman was better for their business than making Goldman eat the error.
But, in this age of computerized trading, errors are going to be made. Another computerized trader without the market power of Goldman wouldn’t get the same treatment.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
Jeffrey Carter is an angel investor and independent trader. He specializes in turning concepts into profits. He co-founded Hyde Park Angels one of the most active angel groups in the United States in April of 2007. He previously served on the Chicago Mercantile Exchange Board of Directors. He has done market commentary for (More...)
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