Yesterday a reader sent me an email. He is going to remain anonymous, but he asked me to write about what happened in the US Treasuries yesterday. I put a request out on Twitter and Stocktwits but I think few people actually knew what happened.
If you aren’t a trader, you need to understand what this means for you. The treasuries affect the interest you pay on your loans, on the interest paid on the federal and state debt. The value of the treasury market plays into exactly how much it costs you to live day to day in the US. Without a stable treasury market, the financial system goes into chaos. That’s why Alexander Hamilton thought it was one of the most important things to get right when our country was founded.
Introduction of treasury futures has saved the us Trillions and Trillions in money because of the efficiency it has brought to the market place. It is one of the most critical contracts traded.
The treasuries ($ZT_F, $ZF_F, $ZN_F, $ZB_F) blew up overnight. Early in the morning. Here is a link to the charts. And here it is visually. Thanks Nanex for documenting.
CME cancelled all the trades. So everything is good right? Wrong.
This sort of thing never happened in open outcry. Before you say I am a Luddite, I am not. This post won’t be about calling for the return of open outcry. A similar thing happened to me in the Hogs years ago. When I was entering an order to buy a ten lot, the market went 100 points higher in the blink of an eye. I didn’t get filled, and I wasn’t short-so it cost me nothing except the opportunity cost of missing the fill.
The message I received is almost exactly like this. I paraphrased some of it and added italics for clarity, but you’ll get the gist. A trader writes:
“I actively trade the yield curve being 5 year 10 year and 30 year. I awoke this morning at 4:00 A.M., and the first thing I do before I decide what trade to look for, is to see where the market has traded. I use T.T. (Trading Technologies) for my platform and this gives me the high and low in the outrights as well as any implied spreads that I watch. The implieds that I trade are the NOB FIT and FOB. (For people that don’t know what this is, they are spreads in the US Treasury market. NOB is Notes over Bonds or Ten Year spread against the 30 year. Traders buy one, and sell the other in a ratio to try and profit from movement)
I look at the NOB first and when I scrolled down to see where the low of the session was, I was in shock to see that the 2-1 implied NOB traded out to 2.09 weak which is 73 full ticks weak on the session (this is a massive move. One tick in the bonds is $31.25, a tick in the notes is $15.625). I can also see the complete trading range of the 10 year because it was small being about 9 ticks so I immediately know that the bonds did something incredibly volatile. (Because the spread moved so much, and the 10 year trading range was small, the other market had to be highly volatile. For anyone that watches interest rate futures, they all move together. If one was violent, the other wouldn’t stand still. The momentum of each might be different-which is why traders can spread and make money.)
While the 10 years were about unchanged on the session, the bonds had almost a 6 point rally, which puts the NOB somewhere around 100 ticks weak based on a 5-3 ratio which is actually what I use. (Trader buys or sells 5 Ten years, and does the opposite in the bonds but only executes 3 contracts)
I immediately called the $CME Control Center to find out what happened, and they told me they were canceling all trades above 131.12. The high before that was 135.23. They wiped out 4 basis points and 13 .32ds They wiped out 141 ticks.($4406.25 per contract)
The bonds did not go straight up, and I know this because I have a friend who has a tick chart of the trade and granted it went up extremely quickly and down quickly, but it wasnt without counter trade on the way up and down. This took about two minutes(in his estimation), which as you know from being a trader is a lifetime. It wasnt a 2 second blip. This was real trade that took a while to run its course. If I was lucky enough to be awake for this, I would have put on a few thousand NOBs. I would have waited about a minute and a half, which as I said is like an eternity, and taken these off for a great profit, but one that would have been well deserved given how thin the market was, and the fear of the bonds continuing sharply higher.
The audacity of the $CME to unwind the bonds by 4.13 points. This is absolutely a bailout of the high frequency firm that had an algo that went haywire(in his opinion). In hindsight I can see that. If I was trading, my perception would have been different given the fear factor that a trader would be experiencing.(this is true, moves like that strike fear into trader’s hearts) The CME was saving this firm, whoever it was from going under. I would be safe to assume if I fat fingered a thousand lot for 4 points the CME would do little if nothing (totally true, CME cares not a whit about independent traders. Not their bread and butter. I have had fat fingers, called and CME did nothing. Cost me a lot of money, over $100,000), because their number one focus is servicing the High Frequency firms.
If you could look into this I would greatly appreciate it , and or expose this for what it appears to me to be. I can only tell you, if I was trading at this time, I would have had a huge position on and it would have been huge gains. If the CME took that away from me, I would be beyond angry. I understand the CME has the right to change prices , but this is beyond outrageous, and appears to be a blatant attempt at bailing out one of these firms that would stand to lose incredible amounts of money.”
There is a lot here, and this shouldn’t be swept under the rug. Ignore the opinion of whether CME was bailing out an HFT firm.
CME has a responsibility to the marketplace to provide clear, orderly and transparent markets. That means different things to different people. As a person who was on a Pit Committee for years, I assure you that responsibility used to be taken extremely seriously by members, and my assumption is the current staff takes it seriously too.
It doesn’t matter who makes or loses money. The exchange isn’t there to pick winners and losers. It does matter that the playing field is level.
In the early days of the S+P trading side by side with the e-mini ($ES_F), the e-mini often would go off the rails. It created havoc in the pit. Risk free arbitrage could be engaged in with reckless abandon. Guys lost and made a lot of money. However, with the demise of open outcry, that free money is gone, but precedents were set back then on busting trades.
At the time, it was early days in electronic trading and it’s fair to say that no one fully understood the full implications of being 100% electronic, nor what the implications in the market place were.
While CME has a responsibility to provide clear, orderly and transparent markets, I am dismayed that they continue to bust trades. At some point market players have a responsibility to the marketplace too. If their algo goes crazy, and they lose a lot of money, it’s up to them to fix it.
What if you sold spreads and then bought them back lower for a big winner? Then CME cancels the trade and you are long above where the market is trading? That’s just as wrong as the algo going haywire.
Back in open outcry days, the CME put a rule in place to stop traders from engaging in the Brazilian trade. Putting a bunch on and waiting at O’ Hare to see if it worked out. If you didn’t have the dough in your account to cover the margin, the profit went to the clearing firm that cleared you because essentially they were bearing the risk of your Brazilian venture.
Each day, in some market somewhere, an algo goes off the rails. I think it’s time for the full pain of the market to discipline the algos. If they lose money, so be it. If they can’t afford to cover their losses they go bankrupt. If that endangers a clearinghouse, then that clearinghouse has a responsibility to the market place to put in place risk controls that stop this from happening.
Having market participants feel the full pain of their actions will cause a cascading effect where firms will make sure their computers work correctly at all times. If not, they bear the risk.
On the flip side, imagine if you had a position that was hurt by this move-or helped. You can’t react fast enough to get out, or in. During the flash crash, I know a person that lost everything. They didn’t cancel those trades.
By cancelling the trades, Exchanges might be doing a disservice towards their goal of a clear, transparent and orderly marketplace. I maintain that the “marginal volatility” of the marketplace at any given point and time is significantly higher today with electronic trading than it was during open outcry.
I know that if I went off the rails and traded wildly, I’d feel the full effect of the market’s discipline and no one would bail me out. If you think you saw volatility in the Treasuries yesterday, you haven’t seen anything yet. Wait until we have greater than 0% interest rates.
What do you think? I’d like to see everyone weigh in. Let’s do it in the comments below not via my email. Be public. Transparency is good.