Legendary futures trader Paul Tudor Jones called for an expansion of daily price limits at the CME Group Global Financial Leadership Conference this week. Jones argued that price limits would have cut by half the decline in S&P 500 futures from Black Monday (Oct. 19, 1987), prevented the bankruptcy of many cotton merchants as a result of a March 2008 spike in cotton and prevented the May 6 “flash crash.”
His comments came as a surprise to many industry insiders in the audience who tend to support less intervention in the price discovery process.
Jones recommended that every exchange traded instrument: securities, futures, options and every form of derivative have a price limit. He includes individual stocks as well. He pointed out that although cotton futures had a four-cent limit at the time of the 2008 spike; traders were able to continue to push the price higher by creating synthetic futures trading deep in the money calls. This same scenario occurred recently in the grain complex. On Oct. 8 corn locked limit up following a bullish U.S. Department of Agriculture (USDA) report but synthetic futures created through options spreads were trading 38¢ higher.
He pointed out that the triggering of the CME’s stop logic function pausing the market briefly helped stabilize the markets during the flash crash when more than “20,000 trades across more than 300 securities were executed at prices more than 60% away from their values just moments before” (some as low as a penny and as high as $100,000) according to the joint Securities and Exchange Commission and Commodity Futures Trading Commission report. He pointed out that “When trading resumed, price stabilized and the S&P 500 began to recover,” but attributed the subsequent sell off in May in individual stock and mutual funds to confidence in the market being shattered.
Jones also proposed that all current limits be reviewed and possibly lowered and that cash, futures and option markets be harmonized “so that we are not forcing liquidity into one arena because another arena is shut.”
He recommends all stock index futures and options have an 8% daily limit both up and down with a 5% move initiating a one-hour timeout. “Anything greater than an 8% move in stocks in one day is probably because of something either so fantastic or so bad that taking more than another day to think about it is a good thing. Hell, most guys spend more than one day picking their fantasy football team,” Jones said.
Jones acknowledged that some foreign markets could continue to trade similar instruments not adhering to limits, but that they would do so at their own peril. In response to a question of how an exchange would margin a contract that is locked limit but believed to be valued much higher or lower, Kim Taylor, managing director and president of the CME Clearing House Division said that the clearinghouse could require higher margin levels based on its risk assessment.