When is an obligation not an obligation?

The investigation of the May 6 “flash crash” is centering on the concept of stub quotes. This is a relatively new practice that allows designated market makers (specialists) to technically meet their obligation to provide two-sided markets without actually doing it.

We noted on this page earlier that markets makers had appeared to disappear during the extreme move on May 6.

We have all heard and some of us have witnessed extreme market conditions where markets makers (the old floor locals) out of safety widened their quotes. There were times locals quoted the S&P 500 in full handles. That is quite a bit different than a stub quote that ranges from a penny to $999,999,999.

Institutional brokers and traders would love to rip on locals for “robbing them blind” but in the old floor days anytime you had extreme market moves that would often come on say an unemployment report Friday, there were locals who busted out. They busted out because they were doing their job by standing in the pit and making a market. Yes some would have their hands in their pockets and during the 1987 crash locals are reported to have turned their badges around for fear someone would simply put a trade into their acronym and they would be stuck splitting a monster out trade.

But these extreme days ended some careers, forced some traders to sell off their membership and pushed some of them into personal bankruptcy as they were basically independents trading their own money. I haven’t heard of any market making firms going out of business because of the flash crash.

Locals would not get away with using stub quotes, yet now that the market making function is being handled by large firms with multi million dollar portfolios, some exchanges allowed the practice of stub quotes.

Trading is better and more efficient thanks to electronic markets but something has been lost with the end of the trading floor. The ability to stand in a trading pit and make a market on a day the unemployment report would be released or a crop report or as the United States was launching a military action takes quite a bit of intestinal fortitude. Yes these traders made a lot of money, but they also faced the prospect of being wiped out in a day. One local reported following the activity in the S&P 500 pit during the 1987 crash going into the members’ bathroom and throwing up. He just made more than $1 million in a few hours but knew it could just have easily gone the other way. But he was there, in the pit making a market.

This post was origninally posted no May 27

About the Author
Daniel P. Collins

Editor-in-Chief of Futures Magazine, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange. Dan joined Futures in 2001 and in 2005 he was promoted to Managing Editor, responsible for overseeing all the content that went into Futures and futuresmag.com. Dan’s incisive reporting and no-holds barred commentary places him among the most recognized national media figures covering futures, derivative trading and alternative investments.

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