Source of Volatility

Terry Flanagan

While high frequency trading is often the scapegoat for market volatility, some market participants assert that the source for wild intraday swings lies elsewhere.

“High frequency trading and algorithmic trading has a tendency to be confused in what is the actual definition,” said Bryan Durkin, managing director and chief operating officer of CME Group during the FIA Expo in Chicago. “The volatility that is frequently referred to is caused by the global economy and marketplace. Academicians continue to look at and dissect activity to determine what has created price movements in the markets, including interest rates, agricultural products and equities. Our studies show that the high frequency trading community has contributed to producing trading volumes and liquidity, reducing volatile situations and tightening the bid-ask spread.”

Regardless of where the market volatility is coming from, the fact remains that it is a very relevant issue, with events such as the “flash crash” still lingering in the minds of investors. Some exchanges at the time already had systems in place to rein in such wild sudden swings in the marketplace.

“We spent a great deal of time developing proactive systems to prevent these situations from occurring,” said Durkin. “On that day, as the markets were cascading, our stock price logic functionality kicked in, causing a momentary cessation in matching, allowing the market to regroup. It provided a temporary cessation for 20 seconds, allowing orders to come in and for orders to be cancelled. After that cessation, the market recovered.”

With increased volatility often comes increased trading activity. Such was the case in September, as exchange operators across the board announced substantial year-over-year trading volume gains. NYSE Euronext for September saw a 23.2 percent increase in global derivatives average daily volume, at 9.5 million contracts, while European cash equities were up 34.6 percent in Europe and up 12.3% in the U.S. year-over-year. Thanks to the flight of investors to the safety of gold in recent months, CME Group experienced record quarterly metals trading volume, up 77 percent from 2010. In September alone, there was an 84 percent bump. As a whole, CME averaged 14 million contracts per day, up 16 percent year-over-year. Total volume was 294 million contracts, of which 85 percent was traded electronically.

The Chicago Board Options Exchange’s Volatility Index, or VIX, reached a high of 48 on Aug. 8, as the markets reacted to the debt ceiling situation and the Standard & Poor’s downgrade of U.S. debt. It then fluctuated through the mid-30s until recently spiking up to above 45 in recent weeks. As of mid-day Oct. 14, the VIX has been trading at about 29, marking the first time the “fear gauge” has been under 30 since Aug. 3.

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