June FTSE Settlement

[Airthrey Capital]

Liquidity is the least of our problems.

If the EDSP bears little or no resemblance to the underlying cash market,..... why trade it at all?

Events such as this will only mean even fewer people trading FTSE futures, putting an even greater strain on liquidity.

A sad state of affairs which needs the serious attention of the FSA, The LSE and LIFFE.

 

[peterpr]

PS What's the UKXSP?
Steve.

Steve
It's a separate temporary index calculated during the EDSP auction by FTSE International with reference to SETS trades during the auction period. As I read the technical stuff, each constituent security that participates in the EDSP auction is suspended from the calculation of the main UKX index until it exits the auction when the '5UP Firm Uncrossed Price' condition is met, at which time it again participates in the main index calculation at the price it left the EDSP auction.

On my reading, for a party to engineer the UKXSP index so far away from the main index would require them to agressively buy a security during the auction and immediately sell once that condition has been met. How to know the condition has been met? Don't know but it looks like somebody does.

I certainly agree that it is likely to reflect very badly on the exchange though. Apparently there was adverse comment on it in the mainstream press on Saturday.

 

[peterpr]

The UKXSP is published in the same way as the other FTSE indices are. The auction is carried once per month (presumably to cater for their full range of options contracts). Here are a couple of charts of it - Monthly and 1 mimute for Friday. It's only calculated for the duration of the auction. From the look of the vast range in April there may have been a 'practice run'. I would have thought that a range like that would have alerted the exchange to possible manipulation of the system.

 

[Windlesham1]

I have to say I thought my machine was up the squiffer-this is blatant manipulation-anyone know if the fsa are investigating ?

 

[Airthrey Capital]

I have to say I thought my machine was up the squiffer-this is blatant manipulation-anyone know if the fsa are investigating ?

I have spoken with the FSA and they have informed me that the Market Conduct Division have initiated an initial review, along with the LSE's FTSE Supervision Team.

 

[stevespray]

I have spoken with the FSA and they have informed me that the Market Conduct Division have initiated an initial review, along with the LSE's FTSE Supervision Team.

Don't hold your breath!

The word is that the FSA are near a conclusion in the case relating to Noah manipulating the May Sheep Dip Futures (BC600MSD)!

Steve.

 

[Rognvald]

This link may help to illuminate:

http://www.ftse.com/indices_marketdata/uk_series/edsp.jsp

and the pdf document "Design of the FTSE Expiry Index" referred to is equally revealing

All this in the interests of market transparency and to facilitate appropriate regulation of course. We must also bear in mind that this came about "following a joint market consultation by the London Stock Exchange and Euronext,liffe, which proposed methods of improving the setting of the Expiry value"

Enjoy!

 

[kriesau]

Liquidity is the least of our problems.

If the EDSP bears little or no resemblance to the underlying cash market,..... why trade it at all?

Events such as this will only mean even fewer people trading FTSE futures, putting an even greater strain on liquidity.

A sad state of affairs which needs the serious attention of the FSA, The LSE and LIFFE.

I've spoken to the LSE about last Fridays EDSP. Their response was as expected - the party line is that the current system was introduced after "more than a year of consultations" with every man and his dog, in conjunction with LIFFE, and last Fridays EDSP clearly "didn't suit everyone" !

When pressed they admitted that they had received many complaints and were therefore reviewing the trades that were made during the auction process ! They confirmed that the EDSP "was calculated by an auction of the constituent stocks at 10.15am where bidders could offer a price that was no further away than 3% from the last automated trade on the Cash Index".

Well clearly, with only a 3% margin either side of the last automated price, there is obviously no scope for anyone to try to manipulate the final EDSP !

Consequently the final EDSP is not derived from the FTSE Cash Index as the underlying instrument, but from the collective constituent stocks that make up the FTSE 100 that are traded in an entirely separate auction with a 3% cap as the only relative parameter to the actual cash index.

This one will run and run and ultimately go nowhere ! They have an approved system which has been used for 8 months - if they find any inappropriate activity during the auction they will refer it to the FSA - if not, then tough ! If your not happy with the system then contact LIFFE because it is their product at the end of the day.

Whether the volume of complaints will prompt a re-examination of the system remains to be seen but I don't hold your breath. Obviously the EDSP just has a nodding acquaintenceship with the FTSE 100 Cash Index but it stands as a virtual independent entity in its own right on expiry date, apart from the constituent 3% cap.

Do they really think such a separate and opaque system is going to encourage people to trade FTSE options in the future when it can produce a outcome such as June 17th !

 

[Windlesham1]

I had a problem with my broker and consulted FSA-all they do is chase little guys who have 'mis-sold' endowments. FOS is an utter waste of time. There is little hope for us small fry when the regulators are all cosy with the enemy! A decent system is long overdue- I will not trade futures for the time being,as I can see these little 'glitches' becoming a favourite weapon of wealth destruction. Still-at least horse racing looks honest in comparison.

 

[Airthrey Capital]

So what is the point in trading a FTSE futures contract whose setllement price is more likely to be determined by the price your neighbour paid for his second hand Volvo than it is by the underlying cash market?

Euronext /LiFFE/FTSE need to examine this or everyone will walk away and trade other instruments in other markets.

 

[Rognvald]

It is necessary to read and fully understand the text under the heading "FTSE 100 Expiry Index" in the FTSE document "Design for the FTSE Expiry Index" to know what is going on here. This material is on Page 5 of the document which is dated 29/11/2004

 

[peterpr]

So what is the point in trading a FTSE futures contract whose setllement price is more likely to be determined by the price your neighbour paid for his second hand Volvo than it is by the underlying cash market?

Euronext /LiFFE/FTSE need to examine this or everyone will walk away and trade other instruments in other markets.

I stopped trading the ftse100 futures a couple of months ago now. Not because of expiry problems like Friday but because, as mentioned by someone earlier, liquidity can be pretty thin these days and with the US dependent gaps at open and close, its becoming quite rare to get tradeable intra-day ranges. I do still monitor it though - more out of habit than anything else really, hence my posts on Friday.

The 250 futures are a complete joke - no liquidity at all and some of the commodities are not much better.

 

[animal]

June expiry - manipulated

(I wrote this on Friday but forgot to send it! - other things on my mind)

Disgraceful manipulation!
The EDSP process run by LSE is now an 'auction' for a couple of minutes at about 10:15am
The outcome was the result of a few big hitters moving the market to suit their positions which they wanted to rollover.
(those doubters that scoff at this, look at the trades for BP and VOD etc at that time)
The trades were real and moved the underlying with the consequent effect on the future.
They had to hold it for about 2mins

I was short 5075 calls which were all set to expire around zero. Suddenly they have 63p intrinsic
That's £630 loss per contract - Ouch!

I can't see how you can have a sensible cash management policy for an event like this other than buying back the positions somewhat in advance.
I can't see that it will be possible to do this ever again on expiry day though.

For those who are fairly new to this, a warning.
The idea that out of the money options expire to zero on expiry day as expounded by most textbook theory is now dead in the water.
It may have a further profound effect on the market which has already changed in character since the introduction of the auction

Its back to the drawing board for me having been very comfortable for a few years

I think the FSA should be investigating why Liffe/Euronext failed to conduct an orderly market but whilst a few questions may be asked nothing will be done.
The dogs are eating dogs.

*******************************************************************************
An update
There were some huge trades 1.6Bn shares in BP during the auction for example

Apparently the FSA is in discussion with LSE and LIFFE
The trades are being investigated
Of course the trader will say that they placed the trade at that time to take advantage of increased liquidity
If they find evidence to the contrary and fine them, that would open the way for a class action against the culprit.

Either way the basis of the settlement will change

There is also a meeting of APCIMS derivatives committee on Monday (I spoke to a member)
If nothing is done by FSA (cynically, why should they bite a hand that feeds) They may come out and simply advise private clients not to participate in this market

 

[Airthrey Capital]

Article which appeared in The Telegraph.....



http://www.telegraph.co.uk/core/Con...ml?xml=/money/2005/06/18/cnwitch18.xml&site=1

 

[kriesau]

(I wrote this on Friday but forgot to send it! - other things on my mind)

Disgraceful manipulation!
The EDSP process run by LSE is now an 'auction' for a couple of minutes at about 10:15am
The outcome was the result of a few big hitters moving the market to suit their positions which they wanted to rollover.
(those doubters that scoff at this, look at the trades for BP and VOD etc at that time)
The trades were real and moved the underlying with the consequent effect on the future.
They had to hold it for about 2mins

I was short 5075 calls which were all set to expire around zero. Suddenly they have 63p intrinsic
That's £630 loss per contract - Ouch!

I can't see how you can have a sensible cash management policy for an event like this other than buying back the positions somewhat in advance.
I can't see that it will be possible to do this ever again on expiry day though.

For those who are fairly new to this, a warning.
The idea that out of the money options expire to zero on expiry day as expounded by most textbook theory is now dead in the water.
It may have a further profound effect on the market which has already changed in character since the introduction of the auction

Its back to the drawing board for me having been very comfortable for a few years

I think the FSA should be investigating why Liffe/Euronext failed to conduct an orderly market but whilst a few questions may be asked nothing will be done.
The dogs are eating dogs.

*******************************************************************************
An update
There were some huge trades 1.6Bn shares in BP during the auction for example

Apparently the FSA is in discussion with LSE and LIFFE
The trades are being investigated
Of course the trader will say that they placed the trade at that time to take advantage of increased liquidity
If they find evidence to the contrary and fine them, that would open the way for a class action against the culprit.

Either way the basis of the settlement will change

There is also a meeting of APCIMS derivatives committee on Monday (I spoke to a member)
If nothing is done by FSA (cynically, why should they bite a hand that feeds) They may come out and simply advise private clients not to participate in this market

I was caught too with short Calls at 5125.

I think that there has been such a furore about this that LIFFE/LSE will seek a solution going forward to try and restore some confidence in the integrity of the EDSP process. There are an awful lot of very pissed people and I know that brokers, the LSE and LIFFE have been inundated with complaints. The current auction process is clearly flawed and this situation can and will occur again in the future unless it is addressed quickly.

 

[Rognvald]

"Most plants and animals exist because they have successfully adapted to changes in their environment. When an organism is unable to change or deal with evolving environmental stress, it will die and the species may be threatened with extinction. Organisms able to cope with the new stress tend to survive. Over time, natural selection and evolution enhance adaptations. These adaptations to a changing environment can take varying amounts of time to occur. Some adaptations happen quickly. The immunity of insects to pesticides is one example. Other adaptations can take thousands of generations or even millions of years to occur. The loss of eyes by true cave dwellers (troglobites) is an example of a slow adaptation."
From "Race for Survival" - a US National Parks document.

A choice is available to us. It is our individual decision and responsibility as to how we exercise it

 

[kriesau]

"Most plants and animals exist because they have successfully adapted to changes in their environment. When an organism is unable to change or deal with evolving environmental stress, it will die and the species may be threatened with extinction. Organisms able to cope with the new stress tend to survive. Over time, natural selection and evolution enhance adaptations. These adaptations to a changing environment can take varying amounts of time to occur. Some adaptations happen quickly. The immunity of insects to pesticides is one example. Other adaptations can take thousands of generations or even millions of years to occur. The loss of eyes by true cave dwellers (troglobites) is an example of a slow adaptation."
From "Race for Survival" - a US National Parks document.

A choice is available to us. It is our individual decision and responsibility as to how we exercise it

If this is supposed to be some kind of philosophical message or analogy to what happened last Friday then it's meaningless.

We are neither primitive animals, insects or plants and we are not prisoners of a particular financial environment either. Financial structures are man made products and we are not destined to be helpless victims of whatever system may be in operation at any given moment in time. If the system doesn't work for us then we have the capacity to reject it, ignore it or change it.

Last weeks EDSP illustrated a flaw in the settlement calculation process. The LSE, LIFFE and the FSA are all aware of this and are all looking at it. This does not guarantee change in the short term but it will produce change in the intermediate or longer term.

Why ? - because if it does not, a large number of traders will cease to invest in FTSE Index Options and that will create liquidity problems in the market and the operators on the Exchanges will ultimately be forced to change it to a system that is regarded as acceptable and credible to the necessary number of participants.

I would be willing to bet that the current EDSP system will either be amended or changed by the end of this calendar year.

 

[animal]

I think its what I call "Red Queen theory" after Alice in Wonderland where the queen was running on the spot to standstill.
We all have to work to balance increased competition.

One strategy that come to mind is that every time futures and options expiry comes round together, try to buy a load of close to the money calls and puts for say a 1p
The speculation is that the market WILL be moved during the auction and a profit will be available

Its a bit obvious though and I guess the MM's will see you coming and neutralise it
The probability is that as expiry approaches the price of such options will increase with the risk

 

[A Dashing Blade]

Same thing happened in Jun 1991 iirc, BZX wanted it up, Morgan Stanley wanted it down, I was running a 100 lot FTSE futures spread (it was £25/point in those days!)

Serious point, I've never understod why option writers fail to close out for 1-2p prior to expiry rather than hang on till the bitter end.

 

[peterpr]

If this is supposed to be some kind of philosophical message or analogy to what happened last Friday then it's meaningless.

Quite so.

The FTSE100 has still not traded anywhere near Friday's futures expiry. The general purpose and theory underlying futures contracts is that they expire at the price of the underlying instrument on which they are based. If expiry is based on something different, as is now the case with the LIFFE FTSE contract (IE the UKXSP index). which can produce a settlement figure so far removed from the index on which it supposed to be based as to be meaningless, then the expiry mechanism/calculation is clearly compromised and so is the contract itself. Doesn't matter that there was 'wide consultation' + all the other excuses trotted out by LIFFE. The fact remains, the contract is compromised and people will treat it accordingly.

I'm not complaining. I was not affected either way. I do know that if LIFFE want to be taken seriously as a robust futures contract provider they'll have to change their EDSP method again at the very least. I certainly won't be using either the 100 or 250 contracts again - what with their astronomical exchange charges as well.