
Tricky Twins Spoofed Trading Computers - jonbaer
http://www.bloombergview.com/articles/2015-12-03/tricky-twins-spoofed-trading-computers
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lordnacho
Ex options trader here. Something about the ingenuity of this scheme is
familiar.

So basically they make two firms, and each quarter swap which firm is doing
the business in order to get privileges that only firms that haven't traded
much in the previous period would earn. I wonder how they thought the SEC
would not find this out, that there's two companies outside a financial centre
with owners of the same name and birthdate, alternating their trades.

I wonder if it's going to be considered a loophole that will be closed or an
abuse. I suppose it could be either.

The other thing, gaming the algos, I have a good idea of how it might have
happened.

You see, options people (the ones I know) are not as technologically
sophisticated as stock people or futures people. Many of them rely on quite
simple systems to quote their orders. Several of these are off-the-shelf
systems with functions you'd expect: an autotrader than joins the BBO in some
size, on every single option, not particularly fast either. This works fine
most of the time because options traders are not overly concerned with the
action on a specific option; they need to know their delta/gamma/vega, and
those can all be thrown in a big bucket to be hedged as appropriate. The
spread is normally quite wide, so as long as you're not being gamed on
everything, you have ample room to lock in some profits.

People writing sophisticated algos (whom I also know) know how to do an ignore
size, ie don't just blindly follow a tiny order.

~~~
itchyouch
Regarding the "options people not being as technically sophisticated" One of
the stories from the former PHLX Options Exchange, now part of the Nasdaq
umbrella is that their rapidfire price protection feature was one of the
killer features that was a competitive advantage over the other options
exchanges back in the day. Now a days, all the major options exchanges have
this feature.

A market maker required to quote in say 80% (by self-governance rules) of
options in a given underlying has a lot of quotes to update when the market
moves. AAPL has 1000+ options, so a market maker may be obligated to quote at
least 800 options books.

When the market moved, there would be 800 options to update. With order/ack
latency around ~30-50u today, but around 400u-1ms 10 years ago, it could take
almost half a second to 1 second to get those quotes updated. In that
eternity, a fast trader could swoop in and execute against the old quotes to
their advantage.

Rapidfire implemnted an atomic cancellation of orders if too many options
executed on a single side only such as only the bids getting executed. This
significantly minimized the risk of getting eaten alive on say a couple
hundred contracts every single time the market moved.

~~~
bd_at_rivenhill
I know that ISE had some sort of automatic cancellation feature from the
beginning or very close to the beginning, so not sure if PHLX was the
originator of this idea. Also, nearly all electronic options exchanges have a
"mass quote" feature that allows changes in prices over a large number
instruments at the same time. I would expect that this feature is available on
every US exchange and only a few overseas exchanges lack it, and managing the
generation of mass quotes vs exchange message rate limits is one of the more
complicated parts of designing option quoting systems. Finally, there is also
a "cancel by underlying" feature that cancels all options on a specific
underlying; if it is the case that the mass quote doesn't allow quotes to be
cancelled (i.e. modified to 0 size), then the usual approach is to cancel by
underlying and then immediately requote at the new price level.

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bd_at_rivenhill
I've worked in automated option market making in the past; if I were on a jury
hearing this case, there's no way I would convict these guys of spoofing. They
are taking advantage of a feature built in to the market for purposes similar
to this: hiding your intentions. The only people who could realistically be
damaged by this are professionals, retail customers will either benefit from
the tiny bit of extra liquidity added by the 1 or won't be adversely affected
by the hidden AON orders on the other side. The algo traders who complained to
the SEC should be embarrassed at doing so; they should have been burned on a
couple of trades, figured out what they were doing wrong and fixed their code
to compensate. Blindly stepping up your quote or order for size on a 1 lot in
order to capture rebate is just foolish and anyone who can make money off you
for doing so should be entitled to it.

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goodcanadian
I'm having trouble being outraged. Some of their behaviour was clearly
fraudulent, and yet it seems to be a case of obeying the letter of the rules,
but not the spirit.

As for the alleged "spoofing," again, I'm not sure what to say. It is normal
for market makers to place orders on both sides of the market (though not at
the same price). While either order could execute, they certainly don't expect
both to do so. And further, market makers are regularly making and cancelling
orders that they don't expect to execute. I think the court needs to find a
clear distinction in what they did in order to convict them of a violation,
and it is not obvious to me that the distinction exists.

~~~
kasey_junk
The distinction between spoofing and market making is very clear. When a
market maker puts an order on both sides of the market the would absolutely
_love_ it if both orders traded. That is, in fact, how they make money. In
general they would love every single order they put in to trade, so long as it
happens in the right order.

When a spoofer puts in a spoofed order, that order is all cost. Under no
scenario do they want that order to trade. The hard distinction to make in
this case is not between normal market making behavior and spoofing, but
between normal hedging behavior and spoofing. Hedges look like pure costs, but
they are costs you are happy to pay to give up some risk. So spoofing all
comes down to intent, which seems pretty easy to prove when you have chat
transcripts.

Whether spoofing _should_ be illegal is another discussion, and probably one
the legislature should have, but for now while it is illegal, it should be
aggressively enforced as if it's not, it incentivizes the bad actors.

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geophile
The amount of human ingenuity that goes into these stupid, pointless schemes
is a tragedy.

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wyager
If your system has poorly thought out rules, it can be gamed. If these rules
also go against market pressures, it will be gamed. I'd argue that in the case
of these absurdly complicated SEC rules, it should be gamed.

If your stock exchange system (including the technical and legal aspects)
needs a bunch of weird hacky proscriptions on user activity, then it deserves
to fail.

~~~
kasey_junk
Anti spoofing laws can be described in a single sentence. There is nothing
complicated about them.

I'm having trouble coming up with a single rule you could make about trading
that wouldn't count as a weird hacky proscription, if you view spoofing as
weird and hacky.

~~~
bd_at_rivenhill
They can be described in a single sentence, but detecting the difference
between spoofing and legitimate activity can be very difficult, especially
when some participants are trading cross-border and cross-asset; their orders
are reacting to events which are not local to the exchange where they occur
and legitimately change at a high rate because they are being affected by many
different factors.

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jsprogrammer
It sounds like the real issue here is that the exchanges withhold information
from the market.

Obviously the professional/customer distinction manipulation was fraud, but it
is the exchange which doesn't advertise bids/offers they know about.

~~~
ikeboy
But that's fully disclosed. The order type is explicitly not publicized.

~~~
jsprogrammer
Right, so complaining about "hidden" orders is useless. The problem lies with
the exchange, not the strategy.

~~~
ikeboy
The problem is the combination of two orders, which serves to mislead the
market. Merely making hidden orders would be fine, making hidden orders, then
making another order meant to mislead other traders is not fine.

I agree the line isn't so clear.

~~~
jsprogrammer
Any misdirection seems to be the fault of the exchanges.

Isn't it common to both buy and sell contracts in complex arrangements, where
various aspects of each individual transaction "cancel out" other aspects of
other transactions? Assuming you buy 1000 contracts and sell 1, you are net
999 contracts? How is that different from any other options trading strategy?

~~~
ikeboy
For one, the two were made from different accounts, which is suspicious by
itself. If you submit from a single account, you generally can't trade against
yourself.

Second, the buy and sell are the exact same price. So there's no legitimate
reason to both buy and sell at the same price.

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anonu
Another great analysis by Matt.

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boulos
Is there something funny about this situation that makes this footnote true?

> If Makino's one-lot trades never executed against Fineline's big trades,
> they look like spoofing, which is illegal. If they did execute, though, they
> look like wash trades, which are also illegal. Either way, the actually
> important question is whether they were illegally tricking other market
> participants, not whether they were intended to execute.

Wash sales aren't _illegal_ , you just don't get to deduct losses from taxes.
My understanding is that intention to execute _is_ the main determination in
spoofing.

~~~
kasey_junk
A Wash sale & a wash trade are not the same thing. Wash trades are illegal in
US markets.

------
dsmithatx
People who do these kind of things are like heroes to me. All of this trading
is just legalized gambling for rich people. I admit I trade options myself
because I like educated gambling. Still seeing some smart young guys out wit
the lazy algorithms made my day.

