Hypocrisy of the CFTC – Unfair Treatment of Sarao Futures – Globex Rules at Fault

Please note: You will better understand this post if you read the CFTC press release first.(press release: Spoofing-Tactics)

I just read in the complaint regarding Sarao Futures (enfsaraocomplaint041715) published on cftc.gov that

Many market participants, relying on the information contained in the Order Book, consider the total relative number of bid and ask offers in the Order Book when making trading decisions. For instance, if the total number of sell orders significantly outweighs the total number of buy orders, market participants may believe a price drop is imminent and trade accordingly.

Now one futures trader, acting through Nav Sarao Futures Limited, called Navinder Singh Sarao realised that traders trying to front run the sellers visible in the order book can be spoofed. He’s basically bluffing using an algo. Like any good poker player he consideres what his opponents (other market participants) are doing and then came to a logical solution to outsmart them like any person relying on their wits would do, if they could bear the risk of being filled on tens of millions worth of S&P futures.

Why any judge or organisation would protect one trader from another trader is beyond logic comprehensible to me. Anyone using algos to sell when the order book on the sell side is heavy, with no economic or long term trading plan, has no reason to be protected. On the contrary.

As a former trader, I know that it is common to see order books with large orders several price levels above (on the offer) and below (on the bid) the prevailing traded price (for example in ETFs). Many market makers do this, so they catch any large market orders, that would other wise move a traded instrument by several percentage points, but at the same time giving them opportunity to hedge at no loss in the underlying instruments (in the example of Sarao it would be the S&P 500 stocks).

Now if Globex uses this defintion: Globex functions such that the best available bid or ask price must be taken (“hit” or “lifted”) by the market for a trade to occur, before the next available best bid or ask price can be taken.  — then it’s their own fault. In any normal order book you can hit whatever you see in the book, that being the point of the book. On SIX Swiss Exchange for example you can hit anything as long as you don’t move the particular instrument by more than x.x percentage points.

Also, if it is so usual for traders like Singh Sarao to “manipulate” the order book, there would soon be an opportunity for other funds, active traders to take the other side and buy whatever is in the order book. Any market participant familiar with the Globex functions knows, that anything above the best bid and best offer is pure fiction. If they don’t, they didn’t do their homework.

Additionally, if the large offers are moving up, as with the algo Sarao programmed, it should become obvious for the market participants, the CFTC wants to protect, that someone is trying to bluff.

Anything executable in an order book is fair bid or offer. If everyone knows they can’t lift/hit more than the best bid or best offer then, as I said, it’s a mistake Globex is solely responsible for. Sarao just took the bluff to a next logical level. Why the CFTC have to find a scapegoat now is highly unfair and wrong. They are not protecting anyone worth protecting. If they changed their system to make everything in the book visible tradeable, they wouldn’t have a problem in the first place.

In my book, Sarao was risking his money with a fair tactic. Why anyone like the CFTC can come and decide whose tactics are fairer than others, is rather disturbing.

This was also interesting; the sheer volume this one guy trades: “For example, on May 4, 2010, Defendants had established a long position .of over 2,000 E-mini S&P contracts, and over a forty-minute period, then proceeded to repeatedly sell and buy E-mini S&P contracts such that, at the end the forty-minute period, Defendants had established a short position of over 1,500 contracts. This cycle was repeated several times during the day, and Defendants ultimately ended the day flat, profiting $876,823 from this trading. On that day, Defendants had the fifth highest trading volume in theE-mini S&P, trading 130,030 Emini S&P contracts.”

And also the ingenuity of Sarao: “Prior to June 2009, Defendants used an off-the-shelf trading platform commonly utilized by traders in the futures trading industry to place E-mini S&P orders. Beginning in June . 2009, Sarao sought technical assistance in modifying the trading platform to create an automated trading algorithm designed to rapidly place, modify, and cancel orders in theE-mini S&P market. Specifically, Sarao emailed a representative at FCM A and indicated that he needed technical assistance in programming a “cancel if close function, so that an order is canceled if the market gets close.”

Here’s the complaint the CFTC details the allegations in enfsaraocomplaint041715

In the post I wrote about Nav Sarao Futures Ltd.

My main points:

  • Globex should change their order book policy: Anything on the 10 best bid and best ask should be open to being lifted.
  • A trader who was active on 800 trading days, according to the CFTC itself, is highly unlikely to be the trigger or cause of any Flash Crash. Especially as no new tactics were used.
  • The only reason they even noticed him, is probably because on that day of the Flash Crash his orders were the sole ones remaining in the book. The main problem not being his offers, but the fact that everyone else pulled their offers, arbitrage guys not functioning as usual.

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