New U.S. trading curbs will cause more uncertainty

By Jonathan Spicer – Analysis

NEW YORK (BestGrowthStock) – New U.S. trading curbs, however necessary, create yet another layer of uncertainty barely two weeks after the dramatic “flash crash” badly rattled markets, traders and analysts warned on Wednesday.

The U.S. Securities and Exchange Commission unveiled details late on Tuesday of the so-called circuit breakers that would halt trading market-wide when individual shares move sharply to rein in uncontrollable drops.

Investors have mostly embraced the breakers as necessary given the trying times. Still, a flurry of temporary stoppages could soak up liquidity, impact derivatives markets and make for choppy short-term trading, observers said.

“If you put a bunch of stock gaps in the way, you don’t know what’s going to happen after the gap releases,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co in San Francisco.

“There’s a lot of uncertainty of what happens when you just stop things for five minutes. So a lot of people disagree with it. Some people feel it’s the right way to go, but unfortunately, not knowing what the end result is another risk you take when you invest.”

The Senate Banking Committee will hold a hearing on Thursday to examine the whip-saw crash that drove the Dow Jones Industrial average down some 700 points in minutes on May 6, before it sharply rebounded.

SEC Chairman Mary Schapiro, CFTC Chairman Gary Gensler and exchange officials from NYSE Euronext, Nasdaq OMX Group Inc and CME Group Inc will testify at the hearing, reflecting growing anxiety that a cause of the dramatic plunge has not yet been articulated.

The SEC, exchanges and market watchdog FINRA have nonetheless pitched the joint circuit breaker plan meant to avoid a repetition of the episode that rattled investors worldwide and highlighted disparate circuit breaker rules at exchanges.

The trading halts, which roll out in June for a six-month trial period, “would give the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion,” the SEC said on Tuesday.

The new breakers for Standard & Poors 500 index stocks trip when they fall or rise 10 percent in 5 minutes, halting trading for 5 minutes. These details could be adjusted and exchange-traded funds might be added, the SEC said.

Trading in equity options contracts will also pause when the underlying stocks are halted.

“You have to understand that market makers who provide liquidity will take a wait-and-see attitude for reentering the market,” Patrick Mortimer, director of option trading at New Hope, Pennsylvania-based Pipeline Trading Systems, said of the fallout in options markets.

“After a stock reopens for trade you are going to see option bid and ask spreads widen. You are also going to see volatility spike up at least in the short-term until the underlying stock has settled down.”

DAY TRIPPING

A similar circuit breaker would have tripped on less than half of all trading days since the beginning of 2008, according to a Credit Suisse study published on Wednesday.

The breaker would have kicked in an average of about 40 times per day in October 2008 — during the height of the credit crisis — but fewer than 10 times per day excluding the period that year between September and November, Credit Suisse analyst Ana Avramovic wrote in a note.

Under the new plan, the exchange that lists the halted stock will handle the reopening of trading, said a person familiar with how it will be implemented.

But questions remain on how the shares will react to the buildup of orders and investor interest in that five minute period.

“The price is really what we’re concerned with. So anything that we have to do to improve the quality of the marketplace and give the client the right price, I think is a very good thing,” said Doreen Mogavero, a NYSE floor broker and president of member firm Mogavero, Lee & Co, who backs the breakers.

“If people want to continue trading around that five minute break … they’re going to find a way to do it,” Mogavero added.

The SEC, under growing pressure to pinpoint a cause of the May 6 plunge, is also working quickly to improve market surveillance and said it will consider at a May 26 meeting whether to propose the consolidation of audit trails from all U.S. exchanges and trading venues.

“It is always good to see the SEC attempting to protect investors, particularly retail investors,” said TD Ameritrade chief derivatives strategist Joe Kinahan.

“The downside is every time you try to regulate trading, it can adversely affect liquidity and the desire of market makers to take risk.”

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(Reporting by Jonathan Spicer; additional reporting by Doris Frankel in Chicago, Leah Schnurr in New York and Rachelle Younglai in Washington; editing by Andre Grenon)

New U.S. trading curbs will cause more uncertainty