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Mystery Solved: Another Fat Thumbed Trader

Thursday, August 02, 2007 | 10:48 AM

Last night, I wondered if yesterday was an example of a SPUs gunner doing a late afternoon jamjab on S&P futures.

Turns out that 200 point swing was the reversing of a bulge-bracket firm trading error. The following is from a top 5 firm (rhymes with Sheryl), who plainly explains the source of the error, and how its unwind caused the reversal.

"Error at the bell last night (clarification): This error at the bell last night really did contribute to the rally. Bottom line is that one of our competitors inadvertently sold 5346 too many of the SPX Sep 1450 calls and needed to cover them in a hurry. At the time the mkt was down 1% on the day.

In covering, it is likely the crowd front ran the order, exaggerating the move.

Once the move got going, the variance hedging phenomenon kicked in. Most dealers place MOC (Mark on Close) orders to hedge their daily delta risk.

If this theory holds, then they would have put in large sell orders yesterday MOC at around 3:40PM. Once the mkt started to run, their delta position would've changed from net long to net short and they would have needed to buy that much more SPX exposure into the bell. Our index trading desk predicts that for every 2 pt move up in the SPU, dealers needed to buy approx 500MM notional in delta.

With liquidity being lousy right now, that created the violent move."

That makes some sense to me . . .

~~~

For more color on these issues, see our prior post, Beware the Fat-Thumbed Trader!

UPDATE: August 2, 2007 11:30am

There is some disagreement amongst CME traders as to whether it was Goldman's error or Morgan -- but the basic thesis that this was an error trade getting fixed remains valid . . .