June FTSE Settlement

[Airthrey Capital]

Anyone else here somewhat taken aback by the June FTSE EDSP of 5138?......

Cash didn't even trade much above 5092!......

I didn't personally have any June positions open, but interested to hear any thoughts from anyone who was either long or short June FTSE at expiry last Friday, or even those who had in the money FTSE options open at the time of expiry.

What was going on?

 

[danfreek]

I was long from a swing signal I got about a week ago. Of course I'm very pleased I was, but it's slightly worrying because that could have gone the other way too. I think it could have been due to the increased volume in the index from the tripple witching maybe?

 

[Airthrey Capital]

I am aware that it was triple witching.

It is the total lack of correlation with the cash that surprises me.

Am I right in thinking that EDSP calculations on FTSE were changed late last year from calculating average trading prices for a 20 minute period (stripping out outlying trades), to an open auction system?...

If so, maybe that explains the lack of correlation between the EDSP and the cash.

Any answers /explanations welcome.

 

[stevespray]

AC - I would agree with what you have said. I wonder why they altered the settlement process? I know that on previous settlement days (especially on triple witching) the exchange used to issue warnings on potential volatility. On that basis I presumed the changes were made to reduce such expiry volatility. June's expiry didn't really effect me but that is by more luck than judgement. I find the final settlement price a total joke. Surely the basis of a futures product is the market on which the product is based - in this case FTSE 100. As you have pointed out, the cash price comes no where near the settlement of 5138 and, in fact, didn't get within about 50 points of the reflected value.

It seems to me that the current settlement procedures are harmful to the integrity of the exchange as the final prices are no where near the level of the market on which the future is based. These, I guess, are the potential pitfalls when trading 'European style' cash settled derivatives - because there is no option for physical delivery the price can alway be manipulated away from the underlying because there is no room for arbitrage.

Steve.

 

[QKapital]

I wonder how the value in the EDSP Intraday Auction was so much above cash value on the FTSE100. How can the EDSP be above the highest quote on the cash market ? Any value in EDSP ought to be reported in the daily high of the Index traded in the auction!
Also I would like to know which securities there were traded up in order to corner the market and drive up the EDSP index. We were long on FTSE100 Call 5125 June contracts and got surprisingly rolled over due to EDSP at 5138. Rumers say that some big german banks carried out the raid. Kindly some thoughts from overseas!

 

[peterpr]

The spike up to 5137 happened during the last couple of minutes of trading. My guess is that it was the result of time and price threshold 'at market' orders triggered at much lower prices. The contract volume leading up to it was pretty thin but there were over 2500 contracts traded during that last couple of minutes minutes. I posted a few observations at the time on the DOW thread and suggested mods use them to start a new thread because it was quite an eye opener. Here they are again:

http://www.trade2win.com/boards/showpost.php?p=186093&postcount=4889

Originally Posted by JillyB
Futures expiry on the Dow seems to have had a bullish effect with an 11 point rise on CMC.
I see it has had the same effect on the FTSE.
Did anyone else expect this rise?

The shorts just got BADLY burned on the FTSE100 June LIFFE futures contract. It spiked up to 5137 before the contract closed for trading at 10:30. That's a good example of what can happen at contract expiry - nearly 50 points higher than the index high up to that point (pro-rata that's over 100 points on the DOW!). The contract closed for trading at 5131. OK there was panic - but that tells me there's more upside to come today on the Footsie because open interest delivery will be at today's index closing price. Of course it could just have been a load of novices panicking because volume was not exceptional during the spike. In any event those who covered during that spike will be kicking themselves if the index closes below 5130 today.

All great fun isn't it ? - You won't catch me anywhere near the YM June contract today, that's for sure.


http://www.trade2win.com/boards/showpost.php?p=186107&postcount=4894

Further to post 4889 for those interested.

Thinking about what happened on the LX contract an hour ago. It does look as thougn novices got burned - either that or the short covering was the result of a flood of fail-safe time triggered 'at market' orders running up to the contract's trading close. Any cool-headed trader looking at the index and noteing that it was already showing a .75% rise on the day would have calculated that the total rise for the day would have to be over 1.7% for them to out-of-the-money so to speak by holding onto any existing short position. If they had done so they would have confined any covering order to whatever they calculated a likely maximum close to be - 90 points is a bit over the top though ! - haven't had a run up on footsie like that for years.

Still, a good example of the shenanagins that go on in the run up to futures and options expiry - so beware !

Thinking about it further, mods may want to move this and post 4889 to a new thread since it is an interesting and educational topic which other may want to add to. I'll post some charts if anyone is interested??


http://www.trade2win.com/boards/showpost.php?p=186206&postcount=4929

Originally Posted by Minder
If we are seeing a similar spike on the Dow, at what time is option expiry and could we expect a reversal ?

They do things a little differently in the States. For one thing there are 2 separate futures contracts for each of the main indices (one pit traded the other electronic). Pretty much all the volume moves over to the forward month one week and one day ahead of current month expiry (ie a week yesterday). Whereas on the LIFFE the June and September contract volumes were just about even stevens even yesterday. One things for sure, I wouldn't like to second guess what will happen in the US today. Funnymentals say it ought to tank but I wouldn't bet the farm on it - in fact I won't be doing anything today.

 

[stevespray]

QK…

I would agree – Having had time to think about it (and look at the charts again), it does look like something happened to drive the price higher.
If I remember correctly, the settlement priced used to be derived directly from the levels traded in the cash market between 10am – 10.30am. This settlement method appears to have been dispensed with, and replaced by this auction business, late last year.

Having seen Friday’s action and, therefore having thought about the issues more deeply, it is slightly more obvious that there is a huge potential for manipulation of the final price. As you yourself have commented, it almost looks like someone cornered the market and forced prices higher. You ask about the contract in question – As far as I can see it was simply the June (ZM5) FTSE100 Futures contract which showed explosive volumes.

My take on the price movement would be as follows…

FTSE has been fairly range bound of late so people have been writing strangles (selling Puts & Calls) with strikes at the range extremes and collecting fairly easy money. In the week or two leading into expiry FTSE started to break upwards penetrating the topside of its established range. This is obviously a danger for the Call writers who start to find that they are now short of In The Money Calls. This is the potential ‘set up’. If, moving into expiry, we edge higher, there is going to be an obvious demand for the June Futures as the Call writers look to hedge their Calls against potential bigger loses. Therefore you have a situation were a potential ‘avalanche’ can occur – the more people who start to hedge their Calls the more demand there is for the June Future and therefore the higher the price goes and, in turn, this causes even more people to cover. All that is requires is an initial series of large buys which trigger the chain of events to unfold.

The ‘glitch’ in the settlement procedure appears to be that there is no correlation between the settlement price and the underlying index on which the derivative is based. This, in my opinion, is a fundamental flaw. Surely a ‘derivative product’ must have a price which is ‘derived’ ?? If the final settlement is not a derived price, based on its underlying index, then it isn’t really a ‘derivative product’ – It’s a product like any other stock where its price (including its final settlement price) is arrived at purely based on supply / demand (and hence price) at a given moment in time.

I would have to suggest that the old settlement procedure was better simply because, even though it could be volatile, it appears a much fairer and less open to potential manipulation. As I already said, this current method seems to lack integrity.

Steve.

 

[QKapital]

I Just wonder which Securities in SETS were used to drive up the EDSP. If it happened in the last minute it would have been the securities that uncrossed in the end or what?

 

[stevespray]

QK...No trading in SETS was required as the EDSP is no longer established in that manner. I think the EDSP is established by the trading in the Futures contract - that was the point made in my previous post.

Steve.

 

[QKapital]

Hi Stevespray

I thought that the EDSP auction only is carried out in individual securities included in eg FTSE100 - Is the futures trading not closed at 10:10 when the auction commence? Also cash value and futures should melt into the same value when time remaining approach zero. We operate in condor spreads which you referred to as writing strangles on puts- and calls. But covering issued Call options by buying (long) in futures is risky since it is not a perfect hedge in case the futures reverse steeply downwards - so we only cover by offsetting Call buys. But back to the main issue - I can only see that the EDSP can be manipulated through transactions in the underlying SETS securities - am i wrong ?? Kindly Lars Glindtvad

QK…

I would agree – Having had time to think about it (and look at the charts again), it does look like something happened to drive the price higher.
If I remember correctly, the settlement priced used to be derived directly from the levels traded in the cash market between 10am – 10.30am. This settlement method appears to have been dispensed with, and replaced by this auction business, late last year.

Having seen Friday’s action and, therefore having thought about the issues more deeply, it is slightly more obvious that there is a huge potential for manipulation of the final price. As you yourself have commented, it almost looks like someone cornered the market and forced prices higher. You ask about the contract in question – As far as I can see it was simply the June (ZM5) FTSE100 Futures contract which showed explosive volumes.

My take on the price movement would be as follows…

FTSE has been fairly range bound of late so people have been writing strangles (selling Puts & Calls) with strikes at the range extremes and collecting fairly easy money. In the week or two leading into expiry FTSE started to break upwards penetrating the topside of its established range. This is obviously a danger for the Call writers who start to find that they are now short of In The Money Calls. This is the potential ‘set up’. If, moving into expiry, we edge higher, there is going to be an obvious demand for the June Futures as the Call writers look to hedge their Calls against potential bigger loses. Therefore you have a situation were a potential ‘avalanche’ can occur – the more people who start to hedge their Calls the more demand there is for the June Future and therefore the higher the price goes and, in turn, this causes even more people to cover. All that is requires is an initial series of large buys which trigger the chain of events to unfold.

The ‘glitch’ in the settlement procedure appears to be that there is no correlation between the settlement price and the underlying index on which the derivative is based. This, in my opinion, is a fundamental flaw. Sure a ‘derivative product’ must have a price which is ‘derived’ ?? If the final settlement is not a derived price, based on its underlying index, then it isn’t really a ‘derivative product’ – It’s a product like any other stock where its price (including its final settlement price) is arrived at purely based on supply / demand (and hence price) at a given moment in time.

I would have to suggest that the old settlement procedure was better simply because, even though it could be volatile, it appears a much fairer and less open to potential manipulation. As I already said, this current method seems to lack integrity.

Steve.

 

[stevespray]

The Futures trading ceases at 10.30:30. As far as I could observe, the EDSP was the price that the Futures contract settled at at that time.

Need to pop out but will investiagte further this afternoon.

Steve.

 

[peterpr]

My understanding of the contract specification is that the EDSP is determined by FTSE International following the LSE close auction and NOT by LIFFE. In other words the settlement price IS the closing price of the FTSE index at the LSE close on the last day of trading. I think there is confusion here between the last price at which the June contract actually traded (ie its closing price) and the contract settlement price. Any open interest remaining AFTER 10:30 am on Friday will be settled at 5077.6 after an index high for the day (at around 10:30 am as it happened) of 5098.5. Still - a whopping discrepancy.

 

[peterpr]

This has prompted me to re-read the LX contract specification (No 29) at: http://www.euronext.com/trader/cont...0,4860,1732_200488335_____1_202062665,00.html

The EDSP is determined by FTSE International following the LSE closing auction. In other words, it is the offical index closing price on the day of contract expiry. That leaves 6 hours of equities trading on the LSE plus the closing auction between the last trades on the expiring futures contract and the determination of the settlement price of the remaining open interest.

That is my reading of it anyway.

 

[peterpr]

Three in a row here - hope I'm not talking to myself

Attached charts show price action on the index + June and September contracts in the 15 minutes or so up to close of trading (of the June contract that is). An 85 point run up on the June contract !!, 50 or so on the September and just 12 or so on the index proper (after sharp rise of about 40 points at 10:15 followed by a 20 point sag)

Spending a while studying this is an education in itself. There are clearly many possible permutations to explain it but it provides real insight into the inter-market (options, futures equities) dependencies and the pressures on market participants in the run up to contract expiry.

 

[QKapital]

EDSP auction

In a technical paper published by London Stock Exchange : Intraday Auction for Exchange Delivery Settlement Price ("EDSP") , all the principles are described however a bit technical.

As I understand (most) individual Securities will eventually receive a socalled 5UP Firm uncrossed price then they will leave the auction and start again to contribute in the normal UKX index and stop from contributing in the EDSP index. The auction is the same as the SETS closing auction except that there is no volume checking in the EDSP auction. Therefor the Futures prices should have no direct impact on EDSP which is derived from individual uncrossing stocks in SETS (FTSE100 stocks is traded among others in the SETS system). Different Price Monitoring Schemes during the auction should secure fair prices since there are socalled reference pricing rules that will postphone automatic matching in case the auction prices are above or below the calculated reference prices. I still need to know what exactly happened during the last trading hours in the EDSP auction last friday. Kindly Lars Glindtvad

 

[stevespray]

Clearly something doesnt add up here.

Firstly, there is no trade in the Futures after 10.30:30 yet the charted posted (for June) clearly shows price movements and volumes - How can this be so?

Secondly, the settlement price clearly didnt turn out to be a 'fair price' and hence why we are questioning what went on.

I'm struggling to understand how, through the use of an auction, the FTSE could be bid 50 odd points higher without this being reflected in the September contract - surely any procedure which allowed this to happen would be open to massive and unacceptabe levels of abuse?

Surely the exchange are compeled to issue a statement regarding what went on Friday?

Steve.

 

[peterpr]

In a technical paper published by London Stock Exchange : Intraday Auction for Exchange Delivery Settlement Price ("EDSP") , all the principles are described however a bit technical.

Thanks for that QK. Seems I was wrong about the settlement auction. It is not one and the same with the SETS end of day auction. As you say, there is in fact a separate intraday auction which opens at 10:10am. A brief telecon to LIFFE indicates that bidding did not actually materialise until 10:25 on Friday with one large broker/fund doing the lions share . Because it ended outside the index range for the day, an FSA investigation has been initiated.

Can't answer your technical question but have requested info from LIFFE and the LSE will post it if it sheds any light.

 

[peterpr]

Also I would like to know which securities there were traded up in order to corner the market and drive up the EDSP index. We were long on FTSE100 Call 5125 June contracts and got surprisingly rolled over due to EDSP at 5138. Rumers say that some big german banks carried out the raid. Kindly some thoughts from overseas!

My telephoned contacts with LIFFE have elicited just the technical spec papers that you already have. Reading between the lines of my conversation I would say that there is some unease at the exchange. They've clearly been dealing with a lot of angry people and are a bit nervous of the questions I had. They did confirm that an FSA investigation has been started. The guy I spoke said that it was just one source that aggressively bid up the UKXSP index during the last 5 minutes of the auction.

As you say, it would be illuminating to know which stocks traded up - must have been the big ones (BP etc) to have had such a marked effect. If you have a demonstrable interest then I'm sure persistent questioning of LIFFE/FTSE/ LSE staff should produce the answer.

In any event I have to agree that to run 2 separate indexes (UKX and UKXSP) in parallel once each month does rather compromise the nature of a futures contract which by definition should expire at the same price as the underlying instrument/commodity proper.

 

[stevespray]

As you say, it would be illuminating to know which stocks traded up - must have been the big ones (BP etc) to have had such a marked effect. If you have a demonstrable interest then I'm sure persistent questioning of LIFFE/FTSE/ LSE staff should produce the answer.

My opinion, not that its worth much, is that the exchange should be open and honest about what has gone on here - It comes down to 'Exchange Integrity'. In my opinion there is already a lack of liquidity in many of their markets (such as FTSE Options). Having things like this happen is going to make people even more nervous. It can clearly be argued that you're better off trading the S&P Options (rather than FTSE) as there is far more liquidity and far less chance of this type of 'manipulation' occurring. The S&P's pay a far greater premium for options writers.

Steve.

 

[stevespray]

PS What's the UKXSP?

Steve.