I'd like to introduce you to a friend in the oil market, named Optiver. This is one of countless HAL9000 high frequency firms who simply make a market and provide liquidity. The New York Times has a nice piece on this little firm, with the cute name.

  • Traders in the Chicago office of Optiver openly talked among themselves of “whacking” and “bullying up” the price of oil. But when called to account by officials of the New York Mercantile Exchange, they described their actions as just “providing liquidity.”

Errr....

Remember, if you ask any questions about the market nowadays, you have an avalanche of people from inside the game telling you all they do is provide liquidity. Without them, we'd be unable to have a functioning market. Countless posts I (and others) put up on sites like Seeking Alpha that even dare to ask about any potential loopholes that some firms in the HAL9000 league could exploit are met with an army of they just provide liquidity comments. :) Almost as if those retorts are organized. Or maybe it's just the dogma that pervades so much of group think nowadays.

Now of course some of these firms are truly only providing a market making business - skimming off the top and in return providing liquidity (in good times at least) [Meet Getco, High Frequency Trading King]. But if one firm like Optiver can manipulate the oil market (allegedly) just imagine what some of the powerful financial elite could do with all the money they have (much of it now backstopped by the Federal Reserve) in all the other markets. Not that they'd ever take advantage of it to post a 97% winning percentage. [Aug 5, 2009: Goldman Sachs Q2 Winning Percentage: 97%] Or more likely (ahem) Optiver was the only bad apple in the bunch...

Wait a second, Larry Summers once worked for a HAL9000 firm DE Shaw learning the tricks of the trade [Apr 6, 2009: Larry Summers - No Conflict of Interest; He Pinkie Swears] ... hmm... and now he has his hands on the PPT which is like the HAL9000 of our dreams... [May 27, 2009: Daniel Shaffer Notices the Invisible Hand aka PPT] Nah, no connection to strange market behavior - I am sure.

As I said in many pieces, I am sure I don't even know about 80% of the stuff that goes on in the dark allies of the Street, so just imagine what must be happening in those corners when we can see some of the dirty laundry in the other 20%. But don't ask the questions - simply understand that any questioning of tactics must simply be answered with it provides liquidity.

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Let's hear more about our friendly overseas oil trading firm who like countless others does nothing but provide liquidity which helps the rest of us get a better execution on our trades!

  • Its superfast, supersecret oil trading software was called the Hammer. And if the Commodity Futures Trading Commission is right, the name fit well with an intricate scheme that allowed commodity traders in Chicago working for Optiver, a little-known company based in Amsterdam, to put their orders first in line and subtly manipulate the price of oil to the company’s advantage.

Wait a second, I thought this was a piece about providing liquidity. I pray this does not get posted on Seeking Alpha - might cause a firestorm. ;)

  • Transcripts and taped conversations of actions that took place in 2007, included in the commission’s case, reveal the secretive workings of high-frequency trading, a fast-growing Wall Street business that is suddenly drawing scrutiny in Washington. Critics say this high-speed form of computerized trading, which is used in a wide range of financial markets, enables its practitioners to profit at other investors’ expense.
  • In July 2008, the commission charged Optiver with manipulating the price of oil; negotiations over a settlement continue.

Now what is typical on Wall Street is (alleged) wrong doing is found and the financial oligarch settles with the regulator, usually for a sum equal to about a few hours worth of manipulation. Of course they settle without admission of doing anything wrong. I suppose the fee is for following the law. These penalties are almost like a toll - (overheard in an imaginary hallway)

Look, we are going to bilk this silly system (Wild Wild West) where we almost got Bernie Madoff in as SEC Chairman, for all it is worth. I mean... we're going to provide liquidity for all it is worth. Every so often you will catch us providing liquidity, and we'll pay your silly fee for whatever offense - while not admitting we did anything. Then we'll see you right back here in 3-4 years on the next charges. Of course for every 1 thing you catch, we're providing liquidity in 5 other places.

p.s. Main Street = Wall Street... make sure to get that on TV, and please send in your 401k money, we need more fuel for our profits.

Rinse. Wash. Repeat. Anyhow back to Optiver which is not an oligarch and thus appears to be in actual trouble

  • In the cutthroat world of high-frequency trading, success is a function of speed, secrecy and often a bit of intrigue. Few have been more adroit at these arts than Optiver. Optiver describes itself as one of the world’s leading liquidity providers, a trading firm that uses its own capital to make markets. It seeks to profit on razor-thin price differences — which can be as small as half a penny.

And this bullet below is certainly the nexus of this situation:

  • But the extent to which market making (providing liquidity to markets that need it) and proprietary trading (the pursuit of pure profit with a firm’s own money) can properly coexist has become a thorny question for regulators.
  • They are grappling with an exploding business that makes up as much as half the overall trading in the United States and a growing share in Europe as well.

Of course Optiver gives the same defense any HFT firm would offer

  • Mr. Massar said that the company was committed to transparent markets (surely) and that there was no inherent conflict between pursuing profits and making markets (cough) — a view that top Optiver officials had long been trying to convey to regulators when their oil trades were being investigated. (hide the Hammer! pronto!)
  • But their pleadings fell on deaf ears. During a tense conference call in 2007, Thomas Lasala, the chief regulator for Nymex, made his doubts clear about Optiver’s trading strategies. “The market seems to move in reaction to your orders,” he said, according to a transcript of the conversation. “And I don’t think that is a market-making strategy.”

On a serious note, let's take a moment to thank Mr. Lasala - I'm glad someone is watching the providing of liquidity. Granted it took the exchange to catch Optiver rather than the SEC (why is the SEC around again?)

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The bullet point below is the second nexus of the questions we (as in the SEC) should be asking, if they were not a captured institution who will pass some light face saving regulation in the months to come... which will be quickly circumvented.

  • It could well be that Optiver’s cowboy trading tactics are unique to the company. But as concern grows over the effect that high-octane computerized trading is having on markets worldwide, Optiver’s conduct in the oil futures market raises questions as to whether the relentless competition of this business is forcing companies to engage in similar practices.

I'm sure it's a one off...

  • “These are proprietary trading shops that are masquerading as market makers,” said Tim Quast of Modern IR, a consulting firm that advises corporations on market structure issues.

I believe the biggest one is now a bank holding company protected the US of American Taxpayer and rhymes with Foldman Fachs.

  • The spread of high-frequency trading in Europe has lagged behind the United States. But it is now experiencing rapid growth, spurred by arbitrage opportunities that have attracted large American firms like Getco and Madison Tyler.

Just be careful liquidity providers - I think in the socialist parts of the world they actually try to enforce regulation. You might outsmart them, but they are at least trying over there. The foxes are not handed keys to the hen house unlike our local bourses.

  • Amsterdam, as much as if not more than London, has been the breeding ground for local firms seeking the same advantages. Companies like Optiver, All Options, Tibra and others have assumed influential positions in Europe, moving from their original expertise in trading options to the full gamut of stocks, bonds and derivatives as well. Called low-latency trading, this blend of speed and opportunism is the essence of Optiver’s business model.

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Some more background for those interested

  • It deploys a sophisticated software system called F1 that can process information and make a trade in 0.5 milliseconds — using complex algorithms that let its computers think like a trader. And the company is so careful about preserving its secrets that when some traders and engineers left for a rival operation recently, Optiver hired private investigators and subsequently sued the former employees on charges of making off with intellectual property.
  • Founded in 1986 by an options trader named Johann Kaemingk, Optiver has grown far beyond its roots in Amsterdam to trade on exchanges all over the world. It employs 600 people and, judging from the many positions advertised on its Web site, it is still in a hiring mode.
  • Given the vicious competition that exists in the industry, Optiver and other companies have become creative in attracting the smartest people in finance. The dress code is aggressively casual. The company provides free breakfasts, lunches and Friday afternoon drinks, as well as chair massages. (paid for by the retail blokes we are providing liquidity to)
  • And in one recruiting Web video (no longer online), an Optiver trader sitting before four giant trading screens is seen ogling two skimpily clad women as they sit on his thighs. (boo yah...)

Now again as we've written in other pieces, look what the SEC (full of lawyers - rather than computer science PHds or traders or former quants or statisticians is up against) It's like having David chase around Goliath with his sling; might get a lucky shot in every few years but Goldman... err Goliath ...usually has his way.

  • To enjoy these professional fruits, applicants need to subject themselves to three math-based tests to test facility with numbers and the ability to think clearly under pressure. For one of the tests, 80 questions must be answered in under 8 minutes. Sample questions include 0.034 times 0.2, or, if you have a cube made of 10 by 10 smaller cubes, how many are facing the outside?
  • Few of the applicants even get an interview: 80 to 90 percent of people who take the test fail it. People who have worked at Optiver say the average age is young — under 30 — as the company has a policy of not hiring traders from rival institutions, preferring recent university graduates who can more easily embrace the firm’s culture.

Ball game! Checkmate - SEC.

  • “The markets used to be about capital formation,” said Mr. Quast, the consultant. “Now 80 percent of trading is driven by some form of statistical arbitrage. We are buying into a statistical house of cards that could unravel very quickly.”

Nothing more to be said than that - we've posted the same warnings in almost exact same language and we are nothing but a 2 bit blogger...

This will continue until it implodes - as I said, I expect this Black Swan to repeat Oct 19, 1987 but in minutes. Then the Fed will step in and fix it by.... (drumroll) Providing Liquidity. The circle of life. Until then - the orgy continues.

[Jul 18, 2009: Joe Saluzzi Comments on HAL9000]

[Aug 6, 2008: Cramer - Quants and their Machines]