Volatility Series Trading Halts

Transcription

1 AUTHORS Ben Polidore Managing Director Head of ITG Algorithms Philip Pearson, CFA Director ITG Algorithms CONTACT Asia Pacific Canada EMEA United States Volatility Series Trading Halts SUMMARY Single-stock circuit breakers occurred almost 1300 times on 8/24/15 ETFs represent 79% of halts Halts are imprecise but a net benefit Equity market volatility has come roaring back over the past month. As the VIX flirts with levels unseen since the financial crisis and 2% index moves represent a regular occurrence, the typically sleepy months of August and September have been anything but for equity traders. The past month has put global market structure through an unexpected stress test, and we have been reviewing the data for observations. In this note we will focus on trading halts (single-stock trading halts). In the coming weeks, we will look at additional important issues, including some of the effects of volatility on volume curves, spreads, and liquidity. The media has covered the market movement on Monday August 24 th quite thoroughly. In addition to the intensity of the single day market dislocation, one of the more interesting aspects of the session was the historic number of limit up/down halts triggered in individual stocks and ETFs. A regulatory response to the May 2010 Flash Crash, these pauses are generally triggered whenever a stock moves down/up 5%, followed by a 5-minute period before trading resumes 1. To give some context, there were almost 1300 such occurrences on August 24 th ; this figure represents more than 30 times the daily average of 40 halts over the past year. The following day, August 25 th, actually saw the second largest number of stocks being halted at % for stocks in the Russell 1000 and most ETF s, 10% for other stocks. Both numbers are doubled in the first 15 and last 25 minutes of the trading day.

2 2 DAILY TRADING HALTS Number of Trading Halts /2/2014 9/10/2014 9/18/2014 9/26/ /6/ /14/ /22/ /30/ /7/ /17/ /25/ /4/ /12/ /22/ /31/2014 1/9/2015 1/20/2015 1/28/2015 2/5/2015 2/13/2015 2/24/2015 3/4/2015 3/12/2015 3/20/2015 3/30/2015 4/8/2015 4/16/2015 4/24/2015 5/4/2015 5/12/2015 5/20/2015 5/29/2015 6/8/2015 6/16/2015 6/24/2015 7/2/2015 7/13/2015 7/21/2015 7/29/2015 8/6/2015 8/14/2015 8/24/2015 9/1/2015 Date SEQUENTIAL HALTS One peculiar outcome is that 257 symbols were halted multiple times, often in opposite directions. Data on NYSE: CVS, a large cap stock that trades almost 6mm shares per day, can be seen below. The red tinted area is a halt due to limit down and the yellow is a halt due to limit up. This doesn t seem right! CVS TRADING ON AUGUST 24, 2015

3 3 The below represents the frequency of halts for symbols with multiple halts on August 24 th. 85 stocks were halted 5 or more times. HALTS PER SYMBOL Number of Symbols Number of Halts ETFS As has been widely reported, the biggest circuit breaker issues were those affecting ETFs. Some have dubbed the day the ETF Flash Crash. Almost 78% of the total halts were on ETFs, a major departure from a typical limit up/down patterns where ETFs represented 32% of total halts. Many market observers have blamed this on market makers struggling to price underlying assets, often linking this to slow openings and the NYSE invoking Rule 48 limiting the pricing information available 2. This seems to be plausible, and the effect was a real shock to established consensus liquidity expectations for ETFs in a volatile market. TRADING HALTS ON AUGUST 24, ETF NASDAQ NYSE

4 4 OBSERVATIONS Market structure rules and durable price boundaries are necessarily challenged when fat-tail trading occurs. Assume that limit up/down halts follow a normal distribution of outcomes, then August 24 th is a 46-sigma event. Also, 5% intraday volatility may seem like a lot, but some stocks, like LTRP-B shares, are halted multiple times nearly every day and seventeen different times on August 24 th. We share a desire to carefully define behavior as extreme, and perhaps we know it when we see it (Jacobellis v. Ohio), but setting concrete policy guardrails is a tricky enterprise. This is especially true for ETFs where you could halt the underlying securities but not the fund or the inverse is this wise? Hard to say. There are improvements that could be made to the process, but most of them serve to burden the market with more complexity. Below are a few precision (and complexity) increasing suggestions: SUGGESTION Make the limit up/down halt level a function of stock volatility instead of just 5%. Create a high (low) watermark provision that prevents sequential halts in opposite directions. Establish a method to link ETFs and underlying to calculate halt levels and/or market-wide circuit breakers. ARGUMENT AGAINST Everyone would have to calculate the volatility according to some agreed methodology or consume it from an agreed upon third party. Traders would not easily know the limit for a given stock. Traders would have to create some time-series of halts over the day to calculate the current halt levels. Even if you weren t trading the stock one hour ago, you would have to record market data to handle halts gracefully. Only for liquid ETFs like SPY? What about startup ETFs? The market is having enough trouble publishing NAVs as it is; it may be probably unwise to link market structure with portfolio theory.

5 5 So should we just leave it alone? The current rule is a heuristic and one should not judge a heuristic on how often it is wrong; but rather, what the impact is when it is wrong. August 24 th exposed how arbitrary and imprecise the single stock circuit breaker rule can be, but the impact was reasonable for most investors. Stocks eventually traded in a range that was most likely representative of investor expectations, and that s all we can ask of market structure. One improvement that might make some sense with very low complexity cost would be to extend the halt period from 5 minutes to 30 minutes and only allow one halt per day. This would allow investors to really focus on what s happening in a halted stock and get the resumption auction right, a process that currently feels broken. Furthermore, this is in line with the original motivation for this process: the idea that a high-speed market can get a price level wrong and feed on itself, necessitating human-intervention. If limit up/down auctions aren t producing quality price discovery, then the auction parameters should be revisited Investment Technology Group, Inc. All rights reserved. Not to be reproduced or retransmitted without permission Broker-dealer products and services are offered by: in the U.S., ITG Inc., member FINRA, SIPC; in Canada, ITG Canada Corp., member Canadian Investor Protection Fund ( CIPF ) and Investment Industry Regulatory Organization of Canada ( IIROC ); in Europe, Investment Technology Group Limited, registered in Ireland No ( ITGL ) and/or Investment Technology Group Europe Limited, registered in Ireland No ( ITGEL ) (the registered office of ITGL and ITGEL is Block A, Georges Quay, Dublin 2, Ireland). ITGL and ITGEL are authorised and regulated by the Central Bank of Ireland; in Asia, ITG Hong Kong Limited (SFC License No. AHD810), ITG Singapore Pte Limited (CMS Licence No ), and ITG Australia Limited (AFS License No ). All of the above entities are subsidiaries of Investment Technology Group, Inc. MATCH NowSM is a product offering of TriAct Canada Marketplace LP ( TriAct ), member CIPF and IIROC. TriAct is a wholly owned subsidiary of ITG Canada Corp. These materials are for informational purposes only, and are not intended to be used for trading or investment purposes or as an offer to sell or the solicitation of an offer to buy any security or financial product. The information contained herein has been taken from trade and statistical services and other sources we deem reliable but we do not represent that such information is accurate or complete and it should not be relied upon as such. No guarantee or warranty is made as to the reasonableness of the assumptions or the accuracy of the models or market data used by ITG or the actual results that may be achieved. These materials do not provide any form of advice (investment, tax or legal). ITG Inc. is not a registered investment adviser and does not provide investment advice or recommendations to buy or sell securities, to hire any investment adviser or to pursue any investment or trading strategy. The positions taken in this document reflect the judgment of the individual author(s) and are not necessarily those of ITG.