A lot of discussion in the option market of Imtech. The troubled company with a billion debt will start a rights offering worth EUR 600 million. The offering if fully guaranteed by a consortium of banks.  As the current market cap of the company is some modest EUR 200 million, the dilution will be heavy. New rights will be offered with a huge discount, as the banks want to avoid the risk as possible to be stuck with millions of Imtech shares nobody wants.

Arbitrage

As usual, the rights will be trading at a discount and the arbitrage game is on. Sell the shares, buy the rights at a discount and lock in a profit. You won’t be able to borrow the shares as soon as the rights start trading. If you own the shares before the offering, you’ll be receiving rights. But everybody wants to own the shares, without the rights. In-the-money calls start trading at a premium. Be long the itm put and itm call – and exercise the call as soon as the rights start trading.

Short squeeze risk

Another issue is the availability of the shares. The option contracts get a huge contract size, due the recalculation options get a contract size of 400 or even 1000 instead of just 100. When options get a contract size of a 1000, the availability of shares to cover the delta may run out of supply. A short squeeze in Imtech was widely anticipated. The new shares from the offering will take some weeks to arrive.

Other rules

Euronext realized this, and decided to change the rules of the game. Instead of the fixed rulebook for right offerings – the rights will now be seen as a “spin off” company. Options will have a basket of claims and shares as underlying  (package method).  Investors unaware of the risks have been selling deep itm calls with a big premium, and can keep the profit after Euronext stepped in.

Then again, these new rules can be changed again and can only be seen as guidelines. Difficult to trade without a fixed set of rules.

• Official document by Euronext

Proud to publish a guest post by Alexandre Laumonier, which appeared earlier on his website sniperinmahwah.wordpress.com. As an anthropologist he is connecting all the dots in the microwaves networks – using public information on communication towers and dishes in Belgium. Reading official documents, visiting the towers and knowledge of microwaves networks for high frequency trading : a very uncommon combination. 

This is insane: more than 28,000 visitors came to read Part I of “HFT in my backyard”. Some of them are inevitably bots, but my logs reveal the majority to be human readers from bank desks, technology providers and so forth. Who would have imagined a simple map would garner such interest? Microwaves have been used for HFT since 2010 after all. Since so many readers want to learn about these networks, allow me now to continue my story. In order to give you a clear picture of what to find on the map and how to locate all these towers, let’s return to Houtem.

FROM FRANKFURT TO LONDON… AND CHICAGO

In the US, the New York Stock Exchange (NYSE) is currently located in Mahwah, in New Jersey. For the Lenape people who originally lived there, the word mahwah meant “Place Where Paths Meet” – a perfect description of a present day exchange. At NYSE, co-located traders meet in a data center, and microwave paths converge on the roof. In Europe, there are two main data centers in England near London: one to the east in Basildon, the NYSE facility housing the Euronext/Liffe exchanges plus Goldman Sachs’s dark pool Sigma-X; and one to the west in Slough, the LD4 data center containing the BATS exchanges. Frankfurt, Germany is home to the Equinix FR2 data center which hosts Deutsche Börse and Eurex.

There are two types of competitors in the very small world of microwaves. First are HFT prop trading firms: Chicago-based Jump Trading (aka World Class Wireless), Dutch companies Optiver and Flow Traders (aka Global Connect) and DRW (aka Vigilant Global). Some of these firms sell part of their bandwidth to other customers. Second are actual providers: McKay Brothers, Custom Connect and, more recently in EU, NeXXCom or Latent Networks. Their customers are banks, hedge funds, even other HFT firms. Some like McKay are only interested in the Frankfurt-London path, while others such as Optiver, Flow Traders, Jump and Vigilant also join the Atlantic Crossing 1 cable landing station in Whitesand Band, Cornwall, England, to allow data to cross over the Atlantic and go straight to Chicago using US microwave networks. Let’s start with Jump Trading.

AN EPIC AUCTION SALE

Contrary to the legend, the Houtem tower featured by Bloomberg was neither used nor owned by NATO; rather the tower was built by and for the US Army in the 1970s. The tower (and two others located in Belgium, one of which is also now used by Jump) was sold to Belgium in 2006. “Closure of these sites will result in an estimated annual savings of over $84,000 based on a comparison of the current annual operations and maintenance costs to an annual replacement commercial communications cost,” wrote the US Department of Defense. In 2012, the Belgium Ministry of Finance used the same money-saving rationale to auction the tower.

The sale took place in Veurne on December 18, 2012. While the auctioneer is now retired and my request for his phone number was refused by the Services Patrimoniaux office, I did speak with someone who attended the auction. Only eight people attended: the auctioneer, his assistant, a government official, and five potential buyers – two or three Americans including a Jump representative, one large Belgian law firm probably acting on behalf of a competitor and a single observer. Prior, the prospective buyers had all visited the Houtem tower in situ so they entered the auction knowing the tower was in poor shape and required renovations my informant estimated would cost the winner $1,000,000. The starting price was €255,000 and the Belgium government would have been very happy with €400,000. The first tick-size was a €5,000 increment, but after half an hour the price was at €700,000 and the tick-size was increased to €10,000 accordingly.

The auctioneer didn’t know who the buyers really were or why they’d have such interest in a lousy old tower; this unexpectedly high price left him perspiring nervously and calling for a break. Collecting himself in the bathroom, he exhaled quietly, bewildered, “What the hell…” The auction resumed, bids climbing to €1,000,000, €1,500,000, €2,000,000. At this point the auctioneer asked for another pause. Finally, after three and a half hours, the tower was sold for €5,000,000. One attendee quickly left, as his car was parked in front of a police station and the meter was long expired. Another losing bidder approached Jump to ask, “Can’t we arrange?” meaning their company would purchase bandwidth or rent some dish space on Houtem tower. I wish I had been a fly on the wall to confirm my suspicions about which competitor attempted to make arrangements with Jump at the auction deep in Flanders that day.

A CRAZY VISIT TO THE HOUTEM TOWER

Since I missed the tower over my early July holiday, I decided to go back to Houtem with my family at the beginning of September. I spoke with different people from the microwaves industry ranging from Jump’s competitors to technology providers, and they explained how I might conduct my field work. I learned to be discreet, parking my car far from a tower, taking binoculars and a camera, checking the GPS of my mobile and then walking – one is obliged to walk far, as most of the towers are in potato fields. Several expeditions to different towers gave me the practice to perfect my technique before I was confident to approach the object of my visit. At Houtem, I parked near a farm and walked along the Chemin des Limites road near the Belgium-France border. Nearing the site, I noted a van and a workman in the tower’s basement. “Not good news,” I told myself, thinking an intelligence officer should always remain unseen. I began to surreptitiously photograph the Houtem tower:

When the worker came to burn things in the field, I moved closer:

There was none “No Trespassing” sign on the railing so of course I entered only to discover an unexpected windfall – the workman left all the doors open! My 63 year old mum stood guard, eyeing down the worker as I visited each room, taking pictures of the equipment until there, right in front of me, was a big red button functioning as the emergency stop. It was amazing to realize I could have cut the Jump microwaves network just by pushing it. But I didn’t want to bother Jump nor Perseus’s customers, and besides, microwave networks have fiber optics backup so any sabotage would have been useless. A message to the jump lawyers: don’t sue me. I know I was on “private property” so I won’t publish the photographs I took, save this one:

It’s fascinating to see the extremely small basement of a 243 meter tower. These kind of towers are engineering marvels. Here the diameter of the foundation is only 25 centimeters and the structure stands erect only thanks to 48 guy wires. Okay, I have to publish one more photo, as the viewpoint is amazing:

I was actually more interested in trying to jump and climb the tower than cutting the power, but the worker came back so I disappeared quietly.

The tower has been fully refurbished from top to bottom with all new guy wires, but my goal was to check the dishes. When the Bloomberg story came out, there were two dishes at the top of the tower:

My photograph shows three dishes, so Jump added one between early July and early September:

This brings me to the question that so flummoxed the auctioneer: why? Why would Jump pay so much for the Houtem tower? The first reason is height; HFT players need tall towers for speed, and the Houtem tower is the fourth tallest tower in Belgium. The list below expands Wikipedia‘s list of the highest structures in Belgium to include my HFT firm entries:

Since the Houtem tower was owned by the US army between 1974 and 2006, I dug up this document published by the US Department of Commerce in 1979 and titled “Signal Level Distributions and Fade Event Analyses for a 5 GHz Microwave Link Across the English Channel”. The article contains these two charts:

(Incidentally, Jump uses a frequency between 7.448400 and 7.48401 GHz for this 87.8 kilometer path..)

All the HFT competitors have to cross the English Channel from France or Belgium to England. They mainly go to Swingate in the north of Dover, where there are two old towers housing Optiver, McKay and Vigilant, or to Hougham in the south of Dover where Latent and Custom Connect have dishes:

The Swingate towers are located on the famed white cliffs of Dover, at about 141 meters above sea level. However, most HFT competitors link to Swingate from Dunkirk, a city which is at sea level elevation:

In Dunkirk, dishes have been installed on the Tour du Reuze:

For the logic, let’s go back to amend the US Department of Commerce chart:

Without getting too deep into the physics, microwaves don’t travel in straight lines. Depending on atmospheric conditions they bend more or less and mostly downward. This generally extends the reach of towers beyond the straightforward result that Euclidian geometry would yield. Jump’s tower provides only a very limited advantage because the extra distance is proportional to the square root of its height whereas it’s price is more than linear in height. I have not found anyone who has understood why Jump paid such a large price.

I don’t know if Jump was in Dunkirk before purchasing the tower, or if they used another tower in Calais (Mollien, 50°57’23.31″N | 1°52’19.86″E) to link to Swingate. I do know that their current microwave route in Belgium is divided in two parts from Houtem: the Houtem-Swingate path enabling a way to Slough west of London, and the Houtem-Ramsgate path allowing access to Basildon east of London.

THE WAVRE TOWER

Jump uses other towers in Belgium as well. There is a distinct lack of transparency in Belgium radio regulators, but I have found dossier after dossier after dossier after dossier allowing me to piece together some paths:

In Flobecq, another old US army tower, they co-locate with Flow Traders and Optiver:

In Hannut, they co-locate only with Optiver. Comparing this two documents reveals Jump added a third dish in Hannut between February 2012 and February 2013, perhaps after they bought the Houtem tower. In Liège, Jump is alone on a tower but Vigilant and McKay are within 1.07 kilometers:

I only visited one other tower housing Jump, in Wavre near Brussels. The Wavre tower is the third tallest structure in Belgium. Once again, I parked my car from the tower and walked through the fields. Some techs were working at the top of the 250 meter tower, but they looked tiny from my vantage point on the ground. Unlike the Houtem tower, which needs guy wires to remain erect, the Wavre tower is a beautiful “standing structure”:

Wavre is also used by practitioners of the extreme sport “base jumping”. Here you can see two crazy people jumping from the tower – hope they didn’t damage the Jump dishes during their fall:

My reason for trekking to the Wavre tower was that it made big news in Belgium when it was sabotaged last spring. On the early morning of May 24, 2014, a few people started a fire which caused severe damage to the tower – this video coverage in French actually shows Jump dishes in a shot. The tower is property of the Belgium national TV/radio operator RTBF but also supports many dishes used by mobile operators. The fire received such media attention because May 24 was an important election day in Belgium, and the police wondered whether the fire was related to the election. RTBF quickly erected a temporary tower to install mobile, TV and radio dishes, but the Jump dishes stayed on the tall tower because the 50 meter temporary one wasn’t high enough.

During my visit to the Wavre tower, there were still some burnt parts on the ground:

It is certain that all the cables burned, rendering the Jump network ineffective for some time. I wonder if police interrogated any of Jump’s competitors, or anyone who knew a trading firm was on the Wavre tower. As of early September all the cables were knew so the Jump network is likely in good shape. Following are the three big dishes owned by Jump, two pointing to Hannut and the other facing toward Flobecq or Oostvleteren:

HEIGHT AND SPEEED

I would love to know if Jump, Optiver and, above all, Vigilant really use these paths between Newhaven and the Isle of Wight:

The Jump competitor who asked, “Can we arrange?” at the auction for the Houtem tower may not have been asking to install dishes on the tower; rather his proposal might have been to share bandwidth. Despite the small world of financial microwave networks being as silent as the potato fields in which stand their towers, I have discovered that Jump is sharing its network with Perseus and another data provider I’m not at liberty to name. The facts are as follows:

• A microwave link can split bandwidth up into 10Mbps increments.
• The microwave link has an aggregate of 100Mbps. Every 64 byte packet send over these links takes 6 microseconds and change to serialize.
• Each participant sends 64 byte frames of trade data to the service.
• At 10Mbps clients can only send 1 packet every 60 or so microseconds.

Now, imagine every customer in a service sends data at about the same time, a somewhat likely scenario due to the likelihood of one customer sending data nano or microseconds before the next customer and so on. In this thought experiment, Customer 1 is first, taking 6 microseconds to serialize into the 100Mbps microwave link. Customer 2 sends their trade data 2 microseconds later, so they wait 4 microseconds to serialize and another 6 to actually serialize. Customer 3 sends trade data 1 microsecond after Customer 2, waiting 3 microseconds for Customer 1, then 6 microseconds for Customer 2, then 6 more microseconds to actually serialize. Customer 4 is quicker; they send their data 1 nanosecond after Customer 3. And wait 2.999 microseconds for Customer 1, then another 6 for Customer 2, then another for Customer 3, then another 6 microseconds to actually serialize.

This example illustrates the supremacy of the owner of network in terms of speed in a shared bandwidth agreement. Jump shares its bandwidth with Perseus. While Perseus has additional customers, none will be as fast as Jump. This doesn’t mean Jump is the fastest operator in the HFT world, however. Despite purchasing a tall tower in a strategic place, they still aren’t as quick as contenders like….well, I’ll detail the fastest of the HFT competitors in Part III.

It has been little more than a year the discount broker DeGiro started operations. A sort of a sister operation of a small hedge fund, it was new in the business. They understood correctly investors won’t switch to another broker for marginal lower fees. Option fees are a fraction of those at formerly discount brokers Binck and Alex.

They’re currently rolling out their service to the rest of Europe. Apart from Scandinavia, Italy and the UK they are covering the entire continent, even banana republics like Greece and Spain.

All investors switched to DeGiro and lived happily ever after? Unfortunately, no. Everyone should switch at least a portion of their portfolio to DeGiro. But while I’m a fan of price competition, always support the underdog and believe they have a reliable and friendly CEO – there’s a lot to improve at DeGiro. Executing trades in the market is a commodity, once a fixed set of conditions are met. Here are the nine things I hate about trading with DeGiro.

1. Impossible to change password

Was flabbergasted to discover it’s impossible to change your password. You have to stick with your first password, well.. forever. Okay, there’s a work around (“Sorry, I forgot my password“). Don’t tell the hackers in Russia about it. Maybe the rest of DeGiro’s security technology is state of the art. Am afraid not.

2. No trade confirmations

You can’t bother them with new passwords, and they won’t bother you with trade confirmations. They don’t write, they don’t call. When orders are executed there is not such thing as trade confirmations in your mail or as a text message. The Russian hackers can safely destroy your account. You won’t notice until you login again.

3. Dividend mess

Some stocks give the opportunity to select cash or stock dividend. Clients of DeGiro will have no possibility to make decision. They get the cash. It gets even worse when receiving US dividends. The dividend witholding tax for Dutch clients used to be 15% – but is raised to 30% as DeGiro switched from ABN AMRO to Morgan Stanley. They don’t know anything about taxes. Clients are on their own. Nothing is communicated about the matter.

4. Website is a mess

The website interface is horrible and hard to navigate. Finding stocks quickly is difficult. Connected to a lot of exchanges, but finding a regular Dutch stock is giving a headache. When Cees Smit compared DeGiro with a Rumanian version of the Lidl – this was what he ment (also see this review – nl). Finding simple US stocks based on the ticker code isn’t possible. They assume you’ll be using ISIN codes. Sure. No option chain available. Help section is a joke.

5. No fixed rules

In bowling, there are rules. At DeGiro you can’t rely on a set of rules. For example expiring in the money options can be exercised, according to a reaction from their director. Depending on “circumstances and market expectations”. And they take half of the profit (seriously!). Same story with rights offerings. Clients who forget to subscribe to a rights offering and don’t sell their claim can’t rely on DeGiro. Sometimes DeGiro takes action, subscribes to the claim, sells the shares and takes half of the profit. It depends. Case by case.

6. Inexperienced back office

From several traders I’ve understood they felt the need to check closely all trades apart from the ordinary. Once they used the wrong prices when options were cash settled in a take over situation. Trader had cash settlement prices straight from the exchange, but DeGiro used other prices. Was hard to convince them to correct their mistake. However, some KBC clearing veterans joined ship so things will probably have been improved. Also see point 3 on taxes.

7. Limited trading possibilities

Straightforward trading possibilities are lacking. Most painful are the lack of combinations and spreads in the option market. Time spreads, straddles and strangles : all have to be executed in single legs. Less relevant, but still annoying are the weekly stock options which are missing out. The US stock market is served but prices are lagging 15 minutes. While the background of the delayed prices is understandable, the lack of communication about delayed prices is not. You will realize you’re looking at old prices as soon as you try to send an order.

8. No app

DeGiro hasn’t got an app for your phone or tablet. You can do without, using the regular browser – but the website is hard to navigate on a regular computer let alone on a small screen. Don’t even try. It’s probably coming in the future.

9. No communication, no twitter

It’s 2014 and there’s no active twitter account for DeGiro. There’s one, but it seems to be asleep. When website is down or clients seek help – nothing. Especially with all uncertainty about the brokerage and lack of communication about everything this is a missed opportunity. Response time from the helpdesk varies, but it’s weird the exchange Euronext is teaming up with DeGiro on a marketing deal. No trade confirmations, no twitter account and no fixed rules ; but DeGiro is taking over the “retail investor services” from Euronext (pdf - nl). Ironic.

A little bit outside of the scope of this website, but Imtech has been the talk of the town lately. We’ve seen a fat finger trade, claim/stock arbitrage and rumors about firms making or losing millions in the meantime.

The 131:1 rights offering has been a text book example of a messy finance operation. Retail investors holding regular shares received a claim for 131 new shares at 1 cent each. That was a 20% discount of the regular stock price. In reality, these rights can be seen as in the money call options.

Stock price dropped a bit and all rights expired worthless.  Think about it, a modest stock drop and investors losing 96% in a few weeks. Not many folks must have realized the tremendous risk of this rights offering.

There’s more some investors probably have missed. Monday the reverse stock split ratio will be announced. When the ratio is higher than 210 old shares for 1 new one, the contract size for each option will drop from 106 (current situation following the offering) to less than 0.5 share for each contract.

The rules from Euronext are very clear. Regular options have a contract size of 100 shares. They won’t allow options with an underlying of less than one share. If contract size drops below 0.5, all options will be delisted and settled in cash. Reference is the closing price. In Imtech this means calls will settle at 1 cent, all puts will settle 1 cent below parity.

Unsure how exchanges, clearing and brokers will handle such an operation in terms of transaction costs. Very well possible traders and investors will be confronted with unexpected transaction costs for worthless calls. Open interest is large. TOM will follow Euronext, but Eurex will accept options with a fraction of a share as underlying. Imtech, what a mess.

October is not only the month of legendary stock market crashes, also time for updates from Euronext on who’s who in the option markets. Here’s the overview of all stock options with the market makers providing liquidity. Some new firms joined, some others left. Won’t surprise you only two new entrants to game.

New entrants

Commerzbank. Quoting as competitive market maker (cmm) in all ten large caps (ING, Unilever, Mittal etc). The proud new owner of a large chunk of Imtech is also CMM in a dozen small stocks. Don’t really understand why a large bank would like to quote Aalbers or Wereldhave. Worth mentioning, not quoting Imtech. No index trading.

Wolverine Trading UK. Similar to Commerzbank all ten target group big caps and a few smaller ones (like again Aalberts, USG, Wolters Kluwer). No index trading either.

Exit

Last year we had to say good bye to a lot of smaller firms. This time even All Options is throwing in the towel as liquidity provider. Used to be active in smaller stocks last year.

• Archelon Deutschland. Don’t know whether or not they exist elsewhere in Europe. Have been around for quite a long time.
• All Options. Rumors haven’t been good lately, and as of next week they stopped providing liquidity. Understood Allard won’t entirely stop trading, maybe shifting to market taker business model. After all they are still hiring.
• M & M Trading. Small shop shut the doors.
• The Hague Options. Disappeared from the list. Has always been a one man show probably.
• Smart Trading. Similar to the small ones above.
• Inhouse Trading. Similar to the small ones above.
• Goldman Sachs. Not very similar to the ones above. But not on the list anymore.

Who’s trading what

A few market makers are left providing most of the liquidity.

• Susquehanna is in a way the new All Options for Euronext. They quote everything when the rest of the market isn’t interested. The spotlight options, but also stuff like OCI.
• Srocca (/Fluhalp) is quoting everything, using their second license in the AEX as cmm. Just a very few options are left out (Arcadis, Nieuwe Steen etc).
• Webb is trading with their memberships Caerus II and II. Have left the index and Heineken, don’t know is this is related somehow. According to this source they just switched to T-Bricks. (“One of Amsterdam’s largest financial trading firm’s has appointed Tbricks” – right..)
• 323 Trading. Is primary market maker everywhere, including the AEX index.
• Optiver is active this time with three memberships. They have two entities for the large Dutch stocks, and one for Anheuser-Busch Inbev in Brussels. Not active in smaller stocks.
• IMC. Still active as PMM in nearly all stocks, including the index.
• Nino (Kemp) is active in half of the stocks, but not in the index.
• Liquid, Maven, Leopark, Market Wizards, Tibra, Cebulon and Better are only active in the index.

Here’s the pdf with the entire overview. While you’re at it, compare it with last year’s edition (here).

More

Blast from the past. Volkswagen and the mother of all short squeezes. This blog Priceonomics has reconstructed all events back in 2008. The squeeze has caused some post traumatic stress for dozens of options traders. (Via daskapital.nl)

Hong Kong based Algorithmic Trading Group (ATG)  has finally become a member of Euronext, Tom Voute will open the market Friday the 31st. Search here for the video.

Last month Euronext announced to cut fees for option trading for retail investors. In order to match TOM’s transaction fees, the fee was lowered from 40 cents to 31 cent per option. The question is always whether or not the brokers lower the fees to the investors, or are happy to keep the extra profit margin in their pocket.

DeGiro, always keen to capture free publicity with empty promises (Alibaba IPO), announced they would follow suit (link, nl). A drastic cut in the transaction costs, the more you trade the lower the fees. A new low transaction feee of 50 cents per option for the most active traders. Sounds great. This sunday they released their new fee schedule. See below.

Seriously. Other brokers are a lot more expensive, DeGiro doesn’t have an incentive to lower fees. But this new fee schedule is embarrassing. DeGiro seems to have lost touch with reality.

Everyone even getting close to the 10.000 option contracts threshold per month should leave DeGiro and switch to a professional firm (say, Better Options). Suggesting retail investors spending EUR 50k per month on option trading fees. What a joke.

Didn’t see it coming when the news broke last Wednesday. Edwin van der Kruk, nicknamed Joop – since he looks like television mogul Joop van den Ende, left Optiver last month. Even bigger news is that Hans Pieterse left the building as well (although he will still be on the payroll for a few months). Joop did not have a big profile (Quotenet is still searching for him on this image), but Hans Pieterse is known within the trading world.

As someone already mentioned in the comments, the entire senior management has left the firm over the last years :

The silly thing is that Optiver’s kinda flushed their whole management in less than five years. Edwin van de Ven: gone. Randal Meijer: gone. Jelle Elzinga: gone. Hans Pieterse: gone. Joop van der Kruk: gone.

As far as I can tell founder Johann Kaemingk is still active in the risk management business of Optiver. His successor, CEO Paul Hilgers has taken over the helm beginning this year.  One could wonder whether he could get along with Joop and Hans.

Anyway, Henk Willem Smits can stop searching for an image of Joop. He’s not on the large picture (“behind the guy in the yellow shirt”). This is him, in the last century. Photo by Etienne Jong.

As a public speaker, Hans Pieterse is a lot easier to find.

Just ran into this highly entertaining weblog, Churning and Burning. A daytrader at a New York prop firm lost a few bucks in trading some OTC/Pink sheets stocks. Nothing new here, except for the fact he sure knows how to write. The hilarious MS Paint graphics are the icing on the cake.

Although I do know some daytraders who are consistently profitable for many years, daytrading isn’t my game (and “technical analysis”.. ah nevermind). However, I assume everybody in the business has once taken a six figure hit on a bad day (at least, I did). Or sat next to someone who did.

Anyway, with markets slowing down towards christmas it’s a funny read during the day. The guy is not only a comedian, has got some smart things to say.

Online broker DeGiro surprised everybody today. On national television they came with the news TOM’s smart order router (SOR) doesn’t work very well. In fact, the guaranteed “best execution” proved to be fake. To make things worse, apparently a HFT firm has seen enough time to benefit from the trades.

Research paper

The Dutch pdf can be found here – the Smart Order Router has been tested. English version will arrive today (Update: here). In illiquid stocks with high stock prices (Unibail. Solvay etc) a large order was send to the SOR. Similar to Michael Lewis’ Flash Boys the orders arrived at one exchange, after which the HFT traders were given enough time to trade on the other exchanges.

See pages 8 – 10 for interesting details and Bloomberg screenshots. The SOR managed to lose the best offer in the market on Euronext because it started lifting on TOM and Chi-X. It looks like they lifted the second best offer on Chi-x before lifting the lower offer on Eur0next. HFT firm made a quick buck by selling 113.30 on Chi-X and subsequently lifting 113.25 on Euronext. Does not look good.

Willem Meijer (TOM) loses his cool

TOM  and Binck would have a lot of explanation to do, one would assume. I know Willem Meijer as a cool, calm and collected guy. No such thing.  Instead of a mea culpa and let’s fix it – they are making a lot of noise. Still in denial.

• It accuses DeGiro of market manipulation (seriously?).
• “The large orders in illiquid stocks aren’t common so that’s why the SOR doesn’t work” (lol whut?!)
• “The screenshots from Bloomberg are delayed with a few seconds.” (doesn’t matter in quiet stocks, does it?)

I would say the examples from DeGiro are exactly situations were the smart routing could prove it works at all. Nobody needs a smart order routing for 1000 shares of ING.

AFM starts investigating

Anyway, the finance watchdog AFM has started an investigation into TOM’s stock routing system. Meanwhile, TOM and Binck should be thankful they’re not living in the United States. Ripping of customers for few years wouldn’t only hurt your reputation in the US.

Statistics

This whole clusterfuck by TOM puts some other statistics in another perspective. In september over 80% of the stock orders have been executed on TOM or Chi-X. Not strange at when you lose all bids and offers on Euronext to the HFT traders. And the average saving per order? Never believed them anyway..

It’s currently out of fashion, but last years papers were filled with reports of traders getting busted stealing their employers secret software code. We’ve seen the alleged code thief at Goldman Sachs,  Aleynikov.

At Flow Traders USA we’ve learned Jason Vuu has been e-mailing himself several strategies and computer code. Not too smart. Vuu tried to launch his own company, together with his pal Lu. Vuu and Lu face serious prison terms if convicted. Lu will appear in court on February 9, 2015.

Vuu pleaded guilty on “unlawful duplication of computer-related material and unlawful use of secret scientific material”, in return for probation. For both charges the poor fella risks four years in prison.

Glen Cressman, no friends with the Vuu/Lu partners, has been caught too by Flow Traders. Same charges. Mailing himself some lines of code. He has to appear in court next week.

• Source

Somehow Binck reminds me of Van der Moolen in their last months. A listed company and a board which seems to have lost touch with reality. That’s nice when writing a kind of financial blog. Expected a quiet December, but voila : Binck. Time to get the popcorn.

SOR functioning poorly

Contender DeGiro showed credible evidence the Smart Order Router (SOR) of TOM doesn’t function properly. Binck is partly owner of TOM and sends all customer stock orders to this SOR, so kind of a big deal here.

Similar to Flash Boys, the book by Michael Lewis, the customer’s stock orders are routed to several exchanges (Chi-X, TOM, Euronext). But as some exchanges are being reached earlier than others, there’s a window of opportunity for HFT traders to take advantage of the order. (Research paper in English: pdf)

Even professor Menkveld, a very cautious scientist specialized in securities trading, made a relatively straight conclusion “there really seems to be a problem here” with these order executions. Of course, too early to draw final conclusions (maybe it isn’t TOM’s mistake but Euronext is to blame, for example) and more research is required etc.

Hilarious press release

That was last week. Back to the present. Binck released a hilarious press release. They don’t contest the evidence, but still demand rectification from DeGiro. Trying to get the attention away from the ball : the facts presented by DeGiro. In addition Binck claims DeGiro has been manipulating Binck’s own share price. Because the fall in the stock “can’t be explained by other factors” than the news from DeGiro. How sweet.

Remember the pointless lawsuits from Euronext against TOM? Suddenly TOM looks like a fat old fashioned institution, used to a monopoly and unable to compete against a new contender.

Reaction from DeGiro

Reaction from Gijs Nagel, head of DeGiro. Nothing to correct here, the evidence is clear. Here’s the Word document with the official reaction. It’s in Dutch, English version will follow tomorrow. A simple demands for Binck from DeGiro:

Has a HFT trader taken advantage in 11 of the 12 stock orders, by lifting/hitting orders in front of the customer? Yes or No?

Any other reaction would be a distraction from the real discussion. What a great position, when you can ask such a simple question. Binck is maneuvering itself in an impossible position. I’m pretty confident Binck will try to duck the question, denying the flash trades is very tricky given the evidence. This is a text book case of ignoring the first law of holes. If you find yourself in a hole, stop digging.

Pretty big news from the other side of the Atlantic. High speed trading firm DRW Trading has bought smaller rival Chopper Trading. DRW is a giant in the high frequency industry and one of the largest prop trading firms in the Chicago – and the world.

A few years ago the firm, founded by legendary trader Donald R. Wilson (“DRW”), came in conflict over interest options with the CFTC. And from my perspective, they are right.

If you want loyalty, buy a dog

DRW is founded in 1992 and employs some 500 people – with offices around the world. Chopper Trading is smaller (200 employees) and younger. Raj Fernando founded the firm in 2002. Instead of his initials, he has chosen to name his firm after his dog. And well, Don Wilson buys it.

Financial details of the merger haven’t been released.

Bad sign for Chopper

These kind of deals between trading firms aren’t very common, and when they do : it usually isn’t a good sign. At least one of the newly weds is often begging to be saved. Another era, but I remember Saen Options (2009). More recently, Knight Trading wasn’t in perfect shape either.

In this case, Chopper approached DRW. Another sign of trouble for Chopper was the decision a few months ago (November 2014) to shut down the European trading operations. Regulatory burden, sure – but only a burden amidst disappointing results. A year earlier Chopper has been fined by the CME. A tiny $20.000 for excessive orders on the E-Mini Dow futures on Globex on two occasions.

But that’s just speculation. Maybe some shareholders in Chopper felt like gardening and decided to cash out. Or spend more time on charity. Saving animals. Maybe. This Raj Fernando is serious about taking care of dogs by the way. I like this guy.

• Some background on Crain’s

A surprising turn of events last friday. According to Paul Schaink, one of the joint liquidators of the firm, there’s a deal with the insurance company AIG. It will cover most of the estimated EUR 126 million claim against former board members. Details of the settlement will follow in a few weeks.

Judge decided in 2013 it was indeed a case of maladministration bringing down the firm, by especially Richard den Drijver and Hans Kroon. Board members are liable, but the Van der Moolen insurance policy covered most of the damage for both gentlemen.

Land of confusion

Confusion in the press. One newspaper (DFT) brought the news Den Drijver and Kroon could walk without any financial pain. The other one mentioned the board members had to bleed as well (FD). And third, Quotenet had a phonecall with a grumpy Hans Kroon.

Van der Moolen shares not worthless?

It’s still unknown for which amount the claim has been settled with AIG. At least it appears a lot of people will receive substantial amounts. Frank Vogel (GSFS) will top the list. Apart from the usual suspects, it may be possible some cash is left for shareholders.

Yes, a long shot. But with 42 million shares outstanding, there’s not much fantasy required for a few cents compensation per share.

Received a curious message from Google. In line with the “right to be forgotten“, somebody mentioned on this website actually submitted such a request. People who wish to be forgotten usually have a history of petty crime or similar misbehavior they are rightfully ashamed of.

Here’s the full message from Mountain View :

Hello,

Due to a request under data protection law in Europe, we are no longer able to show one or more pages from your site in our search results in response to some search queries for names or other personal identifiers. Only results on European versions of Google are affected. No action is required from you.

These pages have not been blocked entirely from our search results, and will continue to appear for queries other than those specified by individuals in the European data protection law requests we have honored. Unfortunately, due to individual privacy concerns, we are not able to disclose which queries have been affected.

Please note that in many cases, the affected queries do not relate to the name of any person mentioned prominently on the page. For example, in some cases, the name may appear only in a comment section.

If you believe Google should be aware of additional information regarding this content that might result in a reversal or other change to this removal action, you can use our form at https://www.google.com/webmasters/tools/eu-privacy-webmaster. Please note that we can’t guarantee responses to submissions to that form.
The following URLs have been affected by this action:
http://www.amsterdamtrader.com/2013/06/millionaire-traders-under-40.html
Regards,
The Google Team

The good news is only fourteen people are mentioned in the post. A few short trial and error searches revealed a former Optiver low frequency trader doesn’t want to be found. Locked twitter account. Linkedin profile without picture for outsiders.

Why Simon Soet requested removal from Google? Beats me. After all, he was only mentioned because he did well as trader for Optiver. Earned 4 million. Nothing to be ashamed of, I would say. Maybe Simon is planning a career at a socialist political party.

Monday February 9th 2015 the online broker Binck will open the books. The first earnings report after a quarter full of misery. Quite a few figures to check. The consensus is their profit will drop a lot compared to last year’s fourth quarter. I’ve bought a few dozen puts this week. Count on them to deliver results which fall short of even the lowered expectations.

Alex Asset Management in downward spiral

First of all there’s Alex asset management. The idea to invest with lower risks with an automated system selling when markets drop is naive. Markets can behave like this for a year or two ; but trying to time the market with this simple idea will never work in the long run. Period. Missing a few of the best stock market days will ruin your result.

See the results over 2014 for the asset management division. Clients will start to realize they are investing in some kind of folly. If investors realize this, they will (and they should) withdraw their money. It’s not an underperforming stock they’ve invested in, but far worse : a system which will never work. Assets under management will drop below 2 bln, maybe even approaching 1.5 bln.

Some of those terrible v-shape movements in the market lately. Binck announced to fix the problem by adding US stocks. Adding more colors won’t help a thing if you’re betting on the wrong system. Guess what, stocks rise and fall on the other side of the atlantic as well. Binck blames it on the non-trending markets. Sure.

Impairment on Alex

In addition, the VEB has started an investigation in the terrible performance of Alex. Let’s assume the automated asset management will continue to underperform – as any experienced asset manager will expect. There’s a possibility of a significant impairment around the corner. It’s not a side activity, but was seen as a key driver of growth.

Active traders moving to DeGiro

Most money comes from active traders. Jumping in and out of single stocks, turbos and options. Especially the latter can ignite a series of trades (rolling the short calls). Well, this can be done against much lower fees at contender DeGiro. Old people investing a little bit now and then aren’t the cash cows for any brokerage. This being said, the Bols IPO is still bigger at Binck than competitors. A number of 2000 clients signed up for the shares, with DeGiro having 300 clients for Bols.

Number of accounts will remain the same. But if any retail investor is like me, then the boring passive investments remain where they are (Binck, Lynx, IB) but the active trading will be done from a brand new DeGiro account. This will hurt Binck – as they are dependent on a small group of very active traders. Their website is slick, but not ready to pay for it.

Binck client flow given to HFT sharks

Finally, there’s the conflict with DeGiro. Binck was accused to sell out retail orders to HFT sharks. Probably by accident due a dumb router. Still, DeGiro seems to be correct. Binck announced to sue them. Talk is cheap (supply excess of demand). They won’t do it. Binck is hoping everybody will forget about it. Don’t count on it.

Interest rates are zero

In a high interest rate world, there’s free money to be made. After all, they have a bank license. Get a nice interest spread on all the money clients have in their accounts. Unfortunately for Binck, the interest rates aren’t what they used to be.

Unable to sell Able, Pieter Aartsen fired

The firm had reached a deal to sell Able to French investors BlackFin. Suddenly the sale was aborted last November. Well, bad luck one could say. Blame it on the French. The fact is the whole unit has been dismantled afterwards. This Able / BPO unit does not exist anymore and the responsible director, ceo Pieter Aartsen has been fired.

Able / BPO will be slowly liquidated, according to sources. This in sharp contrast with the official statement the unit may eventually be for sale again. Curious what their statement will be this time. This is quite a big deal. And a disclaimer here, didn’t have this information when I bought the puts this week.

Not heading for guru status

Not really my niche to predict direction of stocks. Expect the results to be awful, but by the time you may read this I risk looking like a fool. Won’t update this post monday, head for iex.nl for the latest news on monday morning.

My earlier post on some negative sides of the new broker DeGiro, 9 things I hate about DeGiro, has drawn a lot of visitors. DeGiro kept on expanding to almost every European country – and by doing so all new customers ended up over here (hi). Even gave some interviews to newspapers in Poland and Denmark.

Truth be told, DeGiro is improving their company and the service. Passwords can be changed, and US dividends can maybe be fixed with a W8-Ben form. But expanding to different countries without taking the time to fix the paperwork is asking for trouble. Especially in tax heavy Scandinavia.

Google translate is maybe not the best way to handle official translations. Anyway, this anonymous comment deserves a bigger audience – so taken the opportunity to bring it to the front page. Also would like to underline the conclusion by somebody else – more points on DeGiro’s todo list.

Alex

One small word on DeGiro’s competitors. Noticed for example that Alex, a Dutch broker owned by Binck, is still claiming to be the best internetbroker (nl). Because it has won an award by some sort of jury. Hard to understand. Was an award from four years ago. Even Alex Asset management wasn’t going downhill back then. Apparently they’ve stopped updating their website four years ago.

Over to Sweden.

Problems in DeGiro Sweden

I have taken a look at De Giro’s Swedish website and found a lot of strange things.

1: Tax mess 1

Swedish banks report a number of things to the Swedish tax authority, and the Swedish tax authority uses these things to automatically calculate a lot of taxes. For example, dividend amounts and foreign withholding taxes are automatically reported to the tax authority, so I do not need to report my dividends or request deduction of foreign tax myself. Foreign banks usually do not do this, and De Giro’s Swedish website doesn’t reveal whether De Giro does this. De Giro tries to attract customers in Sweden, so it would be very beneficial for them to do this. If you have to spend a lot of time on filling in tax forms, paying slightly higher fees may be a better option.

2: Tax mess 2

On De Giro’s website, it says that any cash in your account at De Giro automatically is placed in an investment fund. This has two implications:
– If you use any cash (by withdrawing it to your bank account, by buying securities or by paying a fee), then you sell some of your holdings in the investment fund. Each sale of your holdings in the investment fund needs to be reported on a separate line in your income declaration, and you need to calculate the purchase value, sale value and profit and pay taxes accordingly. The taxes should be close to zero, but it takes forever to do the necessary paperwork.
– If you put more cash in your account (by transferring from your bank account, by selling securities or by receiving dividend), then you buy some more holdings in the investment fund. This also needs to be reported to the tax authority, and you need to pay 0.12% of this amount in tax. Also, if you hold some amount in your account on 1 January each year, then you need to pay 0.12% of that amount in tax. Lots of paperwork to do, and the tax may be quite high.
Swedish banks usually do this paperwork automatically, but I’m not sure whether De Giro does this (see ‘Tax mess 1′ above).

3: Tax mess 3

If I hold shares in a foreign company, I need to pay some dividend tax to the country of the company. These taxes are usually defined in international treaties. In some cases, brokers set up their systems so that a country charges more than the amount stipulated in the treaty, and the shareholder then needs to contact the tax authority in the company’s country to request a refund. Lots of paperwork to do and some fees to pay (postage & sometimes bank transfer fees). De Giro does not reveal for which countries the correct tax will be deducted. If De Giro charges a higher tax rate, but a different broker only charges the tax rate stipulated in the international treaty, then using the other broker sounds like a good idea even if De Giro might have minimally lower fees.

4: Tax mess 4

It says that other people may borrow my shares. If my shares have been borrowed by someone when it is time for dividend, then do I pay my foreign dividend tax in the country of the borrower or in the country of the company? In this situation, I receive my dividend from the borrower, not from the foreign company. Affects which tax rate I should pay and which tax authority I should request a refund from.

5: Website mess 1

The website is messy and contradicts itself. For example, according to point 6.3 in the terms of use (https://www.degiro.se/data/pdf/se/Kundavtal.pdf), it is not possible to transfer finansial instruments from De Giro to accounts outside De Giro, but yet, the price list (https://www.degiro.se/data/pdf/se/Prisoversikt.pdf) states that it costs 10 euros per ISIN to transfer financial instruments from De Giro. If something can’t be done, then why does the price list contain a price for doing this? Also, if I am thinking of trying out a new service, I want to know how much it would cost to stop using the service and move all my holdings back to my current broker, should I not be happy with De Giro.

6: Website mess 2

The Swedish translation of the documents is poor and often difficult to understand. For example, the price list contains an entry called ‘Anmälan till aktiesparträffar’ (‘application to shareholder savers’ meetings’), with a listed price of 10 euros. An ‘aktiesparträff’ sounds like something where you meet some friends at a bar and discuss your current trading at the stockmarket. Hardly something that you would involve your broker in. To get some clarity in what it means, I take a look at the Danish price list (https://www.degiro.dk/data/pdf/DK_Gebyroversigt.pdf) instead, where it says ‘Tilmeldelse til aktionærsmøde’. I take the Danish word ‘aktionærsmøde’ and translate each half of it separately into English: ‘aktionær’ = ‘shareholder, ‘møde’ = ‘meeting’. OK, I know what the English term ‘shareholder meeting’ means: it’s the thing which usually happens once per year where shareholder votes for various things. Called ‘generalforsamling’ in Danish and ‘bolagsstämma’ in Swedish. So if I want to know what the Swedish price list means, I apparently have to consult the Danish price list and translate it back into English. Not very user-friendly. The next thing in the Swedish price list (‘Anmälan till emissioner’) also looks very strange. This seems to mean that if a company needs more money and the shareholders receive rights to buy new shares, then it costs at least 50 euros to exercise the rights offers. Looks very strange; most brokers handle this free of charge. Maybe the entry is meant to mean something else which has been mistranslated.

Due to all of these problems, I have not attempted to use De Giro yet as it might be a bad idea to do so. De Giro’s services on the Nordic market are at about the same cost level as those of my current broker, but De Giro is a lot cheaper on the other markets it offers. Oh well, it is easier to simply forget about De Giro, I suppose, but it would have been nice to get easy access to the Japanese market.

TOM has announced to shut down it’s stock trading venue. In a short statement, strange enough only available in Dutch, it claims the market share of retail stock orders is only between 10% and  20% of all shares traded. And with a market share of 1% in this segment, it’s a loss making operation.

So far for the marketing talk. Market share in stock trading isn’t the most relevant part. Making a profit matters. Running a stock trading exchange looks fairly simple and straightforward to me.

Trouble with HFT

The stock trading part of TOM came under heavy criticism by broker DeGiro. Even ever cautious professor Menkveld thought there’s something wrong with the orders routed through TOM’s Smart Order Engine. Binck promised to sue DeGiro for reasons nobody understands (which will never happen, as I predicted). DeGiro just demanded an answer to the simple question : did HFT benefit from Binck’s retail orders in stocks?

DeGiro was right

Apparently Binck and TOM have investigated the claims made by DeGiro. And hell, they are probably correct. Binck’s reputation was seriously hurt, so something needs to be done. Fixing the Smart Order Router isn’t easy, as getting the stock orders exactly at the same time on different markets is complicated. Read Flash Boys by Michael Lewis.

Shut down operations

An operation with little revenue and big risk in terms of reputation among investors. Easy decision. Frame it with an extra focus on Chi-X. In the options segment they are still doing fine with 50% market share. I bet they’re hoping everyone else will forget about their conflict with DeGiro. Because with this move, one could argue they fully admit their TOM Smart Order Router didn’t work. High frequency traders seem to have taken advantage of Binck’s retail orders.

* Update February 22th

Sources have told me the whole stock trading venue for TOM was nothing more than a required move to gain regulatory approval for opening the option market on TOM. And truth be told, this option market on TOM is working flawless. Depending on a few technical issues, I bet they will be passing the 55% market share against Euronext this year.

Willem Meijer was not amused by the theory linking the close of TOM stock market to DeGiro issue. According to him hardly any financial institutions (retail banks) connected to TOM stock smart order router. Because of this the liquidity providers left TOM stock venue. This wouldn’t match with the story of them making profits of retail orders with high frequency trading strategy.

It has been a while, but the alleged code thieves at Flow Traders USA seem to be escaping from prison. Jason Vuu pled guilty to two counts of “unlawful duplication of computer related material”  and two counts of “unlawful use of secret scientific material”. No petty crime, but felonies.

Ever since the conviction of former Goldman Sachs coder Sergey Aleynikov to a shocking eight years of prison, it seems to be a risk to be employed as programmer in the high frequency trading sector. The Aleynikov story didn’t end with the conviction by the way. Released and sued again (wiki).

Similar to Aleynikov, ex-Flow Trader Jason Vuu was also charged by Manhattan District Attorney Cyrus R. Vance. Vuu was sentenced to five years of probation, and agreed to pay $50k as restitution.

His partner in crime, Simon Lu  (who has no relatives at IMC Chicago) will probably face the same sentence. Lu was not employed at Flow. In an unrelated other case, former Flow Trader employee Glen Cressman has been offered a three year ban from the security business and a restitution of $60k. The judge said he should take it (“very, very generous offer”).

All defendants claimed earlier no part of Flow Traders proprietary trading software called Pit Bull has been copied. By the way, like the names of internal trading software. Pit Bull. Sounds only a little better than Optiver’s Hammer.

Quite some big news today. The Dutch high frequency trader Flow Traders is exploring an IPO. The firm is said to be valued over a $1.1 billion. The news broke just five days after Virtu announced to be reviving their IPO plans. It’s a bull market after all.

Roger Hodinius and Jan van Kuijk founded the firm after working together at Optiver and Newtrade. The latter firm wasn’t as famous as Optiver, but in the open outcry era has been a very profitable firm between 1997 and 2003 in the option trading. Jan worked longer at Newtrade than Optiver, Roger came directly from Optiver. They founded Flow Traders in 2004.

Flow Traders was mainly known as king of the ETF trading. Making a market in the ETF and hedge it with the underlying components. The ETF sector has seen tremendous growth, and Flow should be positioned on the right spot as worldwide liquidity provider. However, investments in low latency connections are heavy. Competition is fierce, for instance new contender Virtu was only founded in 2008.

Flow valued EUR 220m in 2008

Four years later the American investing firm Summit bought a stake of 30% in the firm. Sources have informed me they paid EUR 66 million for the stake, valuing the firm around EUR 220 million. One year earlier, General Atlantic invested $300 million for a 20% stake in HFT firm Getco (valuing it at $1.5 bln). Getco was three times bigger than Flow in terms of headcount at the time (150 vs 50), and had a broker platform which Flow had not. Basically, 220m was a valuation in line with the market. In 2008.

No buyers in 2012

In 2012 Flow Traders has been put up for sale again. Hodenius and Van Kuijk wanted cash out, and probably also Summit was happy to make a profit on their stake. Alas, no buyer showed up for the whole firm. The main reason was the firm wasn’t trying to attract investors for further growth but solely for an exit of the shareholders. And second, the rumor has it they have ben asking too much for a one-trick-pony, as Flow was seen by potential buyers.

IPO this year

Back to 2015. Bloomberg mentioned an amount of EUR 1 billion for the Flow IPO. Interesting enough, the rival trader Getco is currently a listed company as they have bought the remains of Knight Capital Group. One more reminder of the risk investing in a trader. Anyway, Getco KCG Group is currently valued at a little less than $1.5 bln. That’s the same as 2007. Then again, I haven’t dived into the details of KCG’s books.

Question still remains whether the shares will be listed in the USA or in Amsterdam.

High frequency trading is like god. Everyone talks about it, but nobody has ever seen it. Nobody knows how it looks like, although mythical powers are expected. Strong opinions are in general not correlated with knowledge on the matter. But at least high frequency trading exists, that’s for sure.

How high frequency trading strategies work in reality is a rare discussion. Ran into a fresh website explaining in detail how strategies work in identifying low alpha orders in the market. How to make money with a strategy. Distinguishing humans from robots etc. Of course real valuable secrets from the HFT kitchen won’t be shared, and it’s a simplified post. Not always an easy read, but good to get an idea. If it’s your thing, there are a few more posts to find  : mechanicalmarkets.

Following is a guest post from Mechanical Markets. The author has been a cook in the HFT kitchen, so knows what he’s talking about.

Protecting Client Interests: Anonymity in US Equities

Anonymity is the top concern for many market participants and the entire order handling chain has a responsibility to protect traders’ identities. Still, there are plenty of exceptions to anonymous trading in US equities. When is it OK for brokers and exchanges to reveal potentially client-identifying information? In this post I will discuss a few situations where trading is not fully anonymous, briefly outline an HFT strategy that relies on one of these situations, as well as ask some related ethical questions.

Many exchanges allow Broker-Dealers to optionally identify their orders to the entire market (e.g. Nasdaq). In the previous posts, we examined order characteristics in an effort to identify desirable trading partners. In keeping with that spirit, the first thing we’ll explore is the performance of Nasdaq trades identifiable by counterparty MPID (Market Participant ID).

Here is a chart of trades’ performance grouped by MPID relative to the market price. The MPID with by far the most trades is UBSS (UBS Securities).

The orders marked UBSS have dramatically poorer performance over the long term than those marked anonymous. This tendency is robust across stocks with different liquidity profiles (e.g. price, spread, volume). We’ve discussed in earlier posts why the supposedly efficient market has not eliminated this type of disparity.

A gut reaction might be: “Wow, UBS is handling their customers’ orders poorly if they lose that much money when they trade.” I don’t know on whose behalf these orders are generally sent, but it’s a reasonable guess that they’re retail-type clients. Before you say: “typical bank, screwing over the least sophisticated customers,” I’d argue that UBS might be doing exactly the right thing as far as their clients are concerned. If these are orders from less sophisticated individuals, they might well be limit orders with the price chosen by the client instead of the broker; in which case all the client wants is to maximize their probability of being executed at the price submitted, without regard for what happens in the minutes afterward.

By posting them to Nasdaq with the MPID field populated, UBS is essentially putting a giant “hit me” sign on these orders, which should get them a better fill rate, even if the rest of the market is making money off them. Counterintuitive as it may seem, what would be more concerning would be if these orders, instead of performing poorly, actually performed unusually well relative to the market. That would imply that their broker was leaking information to the market by flagging these orders with their MPID, presumably not in the customer’s interest.

Ah, you ask, but this refers to the order’s alpha only when it trades, what if it actually has a poor fill rate and as soon as it’s posted to Nasdaq the price starts to move away from it? Just to be sure this isn’t what’s happening, here is a chart of the market price around the time of submission of said orders, when they are submitted within 10 cents of the NBBO. [1]

UBS hasn’t exactly earned itself a sterling reputation lately (Libor, equities, FX, taxes), but on this one I’m willing to give them the benefit of the doubt.

Unlike Nasdaq, DirectEdge does offer a financial incentive for firms to display their MPID to the market (see “Edge Attribution Incentive Program” here). Unfortunately, DirectEdge charges extra for a subscription to its MPID attributed order data, so I don’t have it available to repeat the analysis for EdgeX. But I would be very curious to see if orders associated with any particular MPIDs have unusual properties, particularly if they perform well versus the market. If so, that would suggest (and of course this is speculation) the possibility that a broker is willing to leak market-impacting client data in exchange for the revenue offered by DirectEdge. Again, I’m not saying this is happening on Edge, but this sort of incentive program is fraught with danger and I can’t help but wonder why it’s even offered. [2]

A Trading Strategy

I won’t bore you with too many details, since we’ve already seen strategies that capitalize on analogous low-alpha orders. The basic idea here is that when we see a UBSS order trade, we send orders trying to trade with any quantity remaining. The below simulation simply does that, sending 1000 share orders on stocks above 30$/shr to mop up the quantity available. Note that the profit margins are about the same if we send 100 or 1000 share orders, which does hint that these (typically large) UBSS orders come from retail clients.

The strategy makes about 100 mils after fees on 4000 trades per day with an average trade size of 250 shares, netting 10k/day (assuming minimal exit costs). Another 5k/day can be had by sending identical orders to EdgeX. And there’s potential for more; the volume can be scaled much higher by submitting the orders at a more aggressive price. This strategy is somewhat latency-sensitive and there’s a noticeable uptick in volume 50us after a UBSS order executes, suggesting that someone is wise to the MPID feature.

The previous posts focused on order properties that could signal the identity of their senders. Orders displaying fewer HFT-like characteristics make for desirable counterparties. Now we see that knowing the broker’s identity also can tell us a great deal about the client. Imagine how much we might make if we knew the broker for every order we encountered!

Ethical Questions

These examples are not the only exceptions to anonymity of the markets. Certainly some dark pools openly advertise that they filter out toxic counterparties or allow users to choose which sub-population of the pool they’d like to interact with (and we’ve seen Barclays get into trouble over their claims of this kind with respect to their dark pool). It’s my understanding that internalizers can see some identifying characteristics of incoming orders. The general idea behind that identification is that it can result in clients receiving a better price on their executions. A market order sent via Charles Schwab may look a lot like a noise trader to Getco and could get executed near the midpoint; another order sent from Goldman immediately afterwards may scare them and won’t get executed at all.

This does sound like good client service, but there are a few issues that deserve consideration. Instead of passing on their market-making revenue to the Schwab client through NBBO improvement, what if some of it were diverted to Schwab itself via payments for order flow? In that case Schwab might have an incentive to share information with Getco that might not always be in the client’s interest. Could Schwab reveal anything that might indicate to the internalizer that the order was sent not from your grandparents’ IRA, but by an executive exercising stock options? Remember from our examples that even mundane information like a timestamp or size can clue us in to who might have sent an order, so Schwab could even unwittingly transmit sensitive data. I have no reason to believe Schwab does so, but it’s a thought that could make investors uncomfortable. [3]

This hypothetical brings us to the definition of front-running. Is it front-running to sell client information to outsiders? If selling the information helps the client, then it seems like the answer should be no. But what if it doesn’t? Let’s say hypothetically the following happens:

1. Broker has clients that tend to continue trading on the same side after their first order
2. Broker forwards such an order from Trader A to DirectEdge.
3. Broker tells DirectEdge to expose it’s MPID to the market. DirectEdge pays broker.
4. Trader B pays DirectEdge for the MPID data.
5. Trader B sees the newly added order and, anticipating the price to move away from it, sends other orders that degrade the fill quality of Trader A’s current or future orders.

It doesn’t sound so different from a broker calling up a friend upon receiving a client’s instructions, the friend using that info to make money, and then handing the broker a briefcase of cash. I’m not a lawyer, but if something akin to the above occurs it would reflect very poorly on any involved parties who understood the consequences. I’ll stress one more time that this scenario is hypothetical; for all I know DirectEdge doesn’t even have subscribers to their attributed data feed.

One final point about the broader consequences of reduced anonymity in markets: even if clients’ interests are looked after meticulously, de-anonymization of traders can result in a two-tiered market with heavy fragmentation. Because noise traders can receive better prices with their identities partly revealed, orders remaining fully anonymous will tend to come from large institutional traders. You could argue that this is exactly what’s happened to today’s markets; retail flow goes through internalizers and institutions are left to fight each other elsewhere, with HFT connecting the two.

[1] “NBBO” here means an approximation of the real NBBO, essentially an estimate based on a subset of exchanges. Note that orders with the UBSS MPID do exhibit significant toxicity if they are submitted at prices more aggressive than the NBBO. Perhaps this is a sign of information leakage coming from the MPID, but given the large size of these orders (~10 times the size of a typical Nasdaq order that improves the NBBO) and their very high fill rate near 80%, I don’t find that thought particularly convincing. The posted plot includes these orders in its averages.

[2] I can think of a rationale behind this attribution incentive program that does not suggest any undesirable behavior. DirectEdge could simply be incentivizing Broker-Dealers who had already decided to reveal their MPID to send their orders to EdgeX over other exchanges. If there are any client orders among these, the Broker-Dealers could have determined that posting the MPID helps clients get a better execution.

[3] The company names here are just placeholders. I don’t know if Schwab does business with Getco or other internalizers, or accepts payments for order flow at all.

Source : mechanicalmarkets.wordpress.com