How Stupid Hedge Fund Computers Shorted Stocks at $0.01

The SEC/CFTC report on the May 6 Flash Crash shows that most of the trade execution against market makers so-called "stub-quotes", or those placed well away from the market, were from short sales. A short sale is a bet that the price of a security will decline in value. This data suggests that computer trading programs were responsible for these low priced trades and may have had serious programing problems.

Stub-quotes are bid and ask quotes from market makers that are placed well away from the market and are not intended to be executed. They indicate that the market maker has pulled out of the market.

In the case of a stock that trades with a bid of $50 and and ask of $50.25, a market maker that didn't want to participate might put in a bid of $0.01 and and ask of $100,000. The market maker places these wild quotes to meet exchange requirements that they maintain a two-sided quote throughout the trading day. The market maker figures that this bid and ask is so far off the market that in a million years they wouldn't be hit. Well that was until May 6th - when they were hit.

The famous $0.01 per share trade in Accenture plc (NYSE: ACN) and other stocks on May 6th were executed because the stub-quote bid was hit.

20,761 of these trades were broken. Of the broken trades, short sales accounted for approximately 70% of executions against stub quotes between 2:45 p.m. and 2:50 p.m., and approximately 90 % of executions against stub quotes between 2:50 p.m. and 2:55 p.m.

While many of these stub quote trades were canceled, you have to ask yourselves "Who would sell a $50 stock at a $0.01 or buy a $50 stock at $100,0000." There is only one logical answer - computers.

There may be computer driven hedge fund models that were programmed to short 'at the market' on a downtrend. The computer recognized the downtrend in ACN and shorted 'at the market'. Well the market happened to be the stub quote - thus a $0.01 execution on a short sale.

So as more and more data comes out about the flash crash, it is becoming clearer and clearer that the crash was related to both computer and human error. The human programmers of the computers did not set the correct parameters for this type of situation.

Changes are now being considered to stop the use of stub quotes. Also, computer trading platform are likely being re-worked.

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