Portfolio Strategy

North America Market Commentary 19 May 2010

Ana Avramovic
AES® Analysis
+ 1 212 325 2438

The Flash Crash Rehashed

Key points
„ In response to the May 6 “Flash Crash”,
the exchanges & FINRA have
announced new circuit breakers to
prevent a repeat.
„ We describe the new rule and analyze
the potential impact such a circuit
breaker would have had over the years.
„ While we do not know exactly what
caused the plunge, we present
interesting facts that highlight the
breadth and depth of stocks affected.
It All Started With…
Theories abound as to what caused the “Flash Crash” on May 6, 2010, when
many stocks and ETFs experienced double-digit losses in a matter of
minutes, then proceeded to rebound just as quickly. The SEC has yet to
issue an official statement about what they believe was behind the sudden
drop; on May 18 they issued a 151 page report that was inconclusive. They
have formed a Joint CFTC-SEC Advisory Committee to investigate the events
in a Senate hearing on May 20, 2010.
While we don’t know what triggered the plunge, we do know the numbers
when it was underway:
„ In the S&P 500 alone, fully half of all stocks suffered an intraday loss of
at least 10%
„ 1 in 25 had a loss of more than 20%
„ Nearly $700 bln of US market value was erased, before recovering
„ Several stocks & ETFs posted prints around zero.
Exhibit 1: Distribution of intraday losses in the S&P 500
140

120
...
Number of stocks with given loss

100

80

60

Exhibit 2: Breakdown by type of security 40

in busted trades
20

Other
0
10% -50% -20% -18% -16% -14% -12% -10% -8% -6% -4% -2% 0%
Stocks
22% Intraday Loss
Source: Credit Suisse: AES Analysis
®

The Immediate Response: Canceled Trades

To address the extreme circumstances, the exchanges invoked their
ETFs “Erroneous Trade” rule with modified terms. Any trades executed after
68%
2:40pm where the print was at least 60% away from the NBBO were
canceled. The rule impacted over 300 securities. Interestingly, the majority
(68%) of the affected securities were ETFs. Furthermore, 10% were other
types of securities such as closed-end funds and natural gas trusts (Ex 2).
**Other includes Closed-end funds; LP's and Unit Trusts
The fact that many ETFs disconnected from their NAV and sold off more than
Source: Credit Suisse: AES® Analysis their underlying stocks suggests that ETF market makers simply withdrew.

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Don’t Blame the Short Sellers

New Exchange Circuit-Breaker Rule In past market sell-offs, people have fingered short sellers for driving down
When it kicks in: If a security moves by 10% prices. In fact, the SEC recently voted to re-instate a modified version of the
within a 5 minute window uptick rule that would restrict short selling (for more on the rule, please refer
to SEC Ups the Bid to Restrain Short Selling).
What happens: Trading halted in the affected
stock for 5 minutes, then re-opens for The new rule will be fully effective by November 10, 2010. However, even if
regular trading, still subject to another the limits were in place during the flash crash, only 38% of the S&P stocks
potential circuit breaker would have been subject to short selling restrictions, because the threshold is
Securities affected: S&P 500 stocks only for measured relative to the previous day’s close, not the day’s high.
an initial 6 mo. pilot period through Dec 10, But, as noted earlier, the cause of the drop was more likely due to a reduction
2010. May then add other stocks & ETFs in liquidity and a lack of bids from market-makers, rather than something like
Applicable hours: 9:45 am – 3:35 pm a short selling bear-raid.
When Effective: The CB will be in place for a 6- Lasting Effects: Circuit Breakers
month pilot beginning in June. Could then
In response to widespread calls to institute a mechanism that would prevent a
potentially become permanent
repeat crash, the exchanges have put forward a rule that would impose circuit
Next steps: There will be a 10 day comment breakers on individual securities (see box, left). The rule comes from the
period once the rule is published in the exchanges rather than the SEC in the interest of time, as an exchange
Federal Register directive can be in place more quickly than an emergency SEC order.
Although some caution that officials should invest more time before altering
market microstructure, in order to properly analyze potential consequences,
Exhibit 3: Average number of CB triggers per day others argue that prompt action is necessary to “restore market confidence.”
40
The official SEC release also notes that they will consider further changes to
35 existing market-wide circuit breakers (which did not trigger on May 6).
number of triggers in 1 day.

30

25
Potential Impact
We have conducted our own analysis of the impact a similar circuit breaker
20
would have had since the beginning of 2008. For a circuit breaker in effect
15
between 9:45am and 3:30pm that triggers when a stock in the S&P 500
10 declines by 10% within 5 minutes, we find that it would have gone into effect:
5
„ Fewer than 10 times per day, on average, for every month except for
-
the extraordinary period from September – November 2008.
Sep-08

Sep-09
Jan-08

Jul-08

Jan-09

Jul-09

Jan-10
Nov-08

Nov-09
Mar-08

May-08

Mar-09
May-09

Mar-10

May-10

„ At the most extreme, in October 2008, it would have kicked in an

Source: Credit Suisse: AES Analysis ® average of around 40 times per day.
„ On the other hand, over the entire period studied, from January 2008 –
Exhibit 4: Distribution of daily circuit breaker triggers May 15, 2010, over half of all days would not have had any triggers at
from Jan 2008-May2010 all. 80% of all days would have seen 3 or fewer triggers.
320
It is important to keep in mind that this circuit breaker would not prevent large
280
jumps at the beginning and end of the day.
240
Also, large moves are common after certain news releases, especially M&A
number of days

200
announcements or earnings. While these often occur outside of market
160
hours, if they were to happen during the hours when a circuit breaker rule is
120 in effect, the news would have a good chance of triggering the trading halt
80 and potentially disrupting the natural price discovery process.
40
Note on our calculations: in our study, we counted the number of times a
0 stock declined by at least 10% in any non-overlapping 5 minute interval from
0 1 2 3 4 5 6 7 8 9 10 20 More
Number of times circuit breaker triggers in 1 day 9:45am – 3:30pm. We did not count up moves, we did not use a rolling 5
Source: Credit Suisse: AES® Analysis
minute window, and we did not consider any subsequent trading halt.

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