The CEO of US options bourse NYSE Amex has recommended greater coordination among exchanges on market maker obligations to prevent serious erroneous trading incidents.
The call follows an incident on NYSE Amex in late February that resulted in 31,140 options contracts being traded at erroneous prices.
Although some obligations already exist for market makers, NYSE Amex head Steve Crutchfield said a more harmonised approach would benefit the industry as a whole.
“What we need to consider as an industry is whether exchanges should have the ability to reject market maker quotes that are erroneous relative to the prevailing price,” Crutchfield told theTRADEnews.com. “While there are already obligations to quote spreads no wider than US$5, there is nothing to prevent a market maker crossing through another market maker’s quoted spread.”
If the prevailing market price for an option is US$3, for instance, there are no restrictions that prevent another market maker from quoting a new price with a bid of US$6 and an ask of US$6.10. While Reg NMS obliges the nine US options exchanges to route marketable orders to other venues if they display the best price – as it does for equities – Crutchfield explains that a mechanism to prohibit a large number of such quotes from reaching the market would ensure closer control of liquidity provision and improve market stability.
“The right method of formalising this is by harmonising exchange rules,” said Crutchfield.
In equities, electronic market makers Knight Capital, Virtu Financial and GETCO teamed up in June 2010 to suggest new responsibilities for liquidity provision following the 6 May ‘flash crash’. During the flash crash, a single erroneous order sent markets sprawling in the space of 20 minutes, before rebounding just as quickly.
The erroneous trading incident on NYSE Amex that occurred on Friday 24 February bore a resemblance to the flash crash. It was sparked by a market maker that sent 31,140 quotes in single contracts priced far away from the prevailing market value to the exchange in 27 seconds, just one minute after the market opened. Shortly afterwards, the market maker requested that NYSE Amex examine the trades as part of its obvious error review policy, an activity that lasted throughout the weekend. Trades that needed to be busted were prioritised ahead of those that only required a price adjustment. News reports have suggested that proprietary trading firm Ronin Capital was the market maker in question, with trading in around 450 symbols believed to be affected.
All NYSE Amex systems continued to function smoothly throughout the incident.
Crutchfield notes that the impact of the incident on the market was relatively minor. The exchange lists over 312,000 options and some market makers can offer liquidity in up to 100,000 instruments.
However, he suggested that the error could have been avoided through better use of the risk management system NYSE Amex supplies to market makers on a discretionary basis. The system allows market makers to pull quotes from the market if executions exceed a firm-specified threshold within a certain time period.
“The market maker in question on had their risk management system set at a pretty high level as their quotes continued to process,” said Crutchfield. “But market makers on the other side of those trades did have quotes kicked out, which led to a temporary widening of spreads.”
As part of its response to the incident, NYSE Amex is seeking encourage greater use of its risk management system and is seeking regulatory approval to lower the threshold firms can set for cancelling quotes. The exchange declined to comment on whether it was planning further action against the market maker that was responsible for the erroneous trading incident.