Bloomberg News

Data Feed Breakdowns Show Market Stress as VIX Lurches: Options

October 31, 2013

Confidence was shaken in the U.S. options market after lines that pipe prices between exchanges malfunctioned, reinforcing concern that arose two months ago when Nasdaq OMX Group Inc. froze trading.

Deutsche Boerse AG (DB1)’s International Securities Exchange, which runs the third-largest U.S. options venue, had trouble sending information yesterday to a marketwide price conduit called the Options Price Reporting Authority. It’s at least the sixth mishap this year with the main price feed for equity derivatives, evidence of the market’s fragility as Securities and Exchange Commission Chairman Mary Jo White pressures exchanges to collaborate on making their systems more reliable.

While trading carried on yesterday, the breakdown gave fresh life to speculation that the structure of American securities markets is fundamentally flawed. The disruption followed Nasdaq’s Aug. 22 data feed error that caused a three-hour halt for thousands of stocks, and comes after the SEC accused two of the biggest options institutions, CBOE Holdings Inc. (CBOE:US) and Options Clearing Corp., of supervisory failures.

“The series of glitches we’ve experienced this year have definitely served to remind us that market risk isn’t the only thing traders have to worry about,” Max Breier, a senior equity derivatives trader at BMO Capital Markets Corp. in New York, said in an interview yesterday. “Operational risk, which is very hard to quantify, may be increasing as the world becomes more reliant on electronic exchanges.”

Opra Problem

Nasdaq’s securities information processor, or SIP, broke down in August, prompting the second-largest U.S. stock exchange owner to halt trading out of concern that the error would cause uneven dissemination of prices. It underscored how quickly the integrity of the U.S. market can be subverted as orders to buy and sell shares are matched on more than 50 exchanges and alternative electronic venues.

“The problem that originated at Opra today that prevented dissemination of ISE’s market data again reinforces the need for the industry to assess single points of failure and to work together to strengthen our critical infrastructure as requested by Chair White last month,” ISE Chief Executive Officer Gary Katz said yesterday in a statement e-mailed to Bloomberg News. “We are committed to working with Opra and the other exchanges to make actionable recommendations to accomplish that goal.”

Market Fragmentation

Like the U.S. equity market, options trading is spread across multiple exchanges, all of them connected by data feeds that ensure buyers and sellers get the best available price. The fragmentation followed a decade and a half of reform on Wall Street aimed at spurring competition among securities exchanges. Critics say the system has bred so much complexity that avoiding breakdowns is impossible.

Errors with the main options price feed have cropped up several times in 2013. The U.S. equity derivatives market was halted briefly on Sept. 16 because of an issue with data from Opra, while CBOE stopped trading three days earlier on its C2 venue when it couldn’t send information to the price processor. Nasdaq reported problems with Opra in January and April. CBOE, the largest U.S. options exchange operator, experienced issues with disseminating data in July.

Breakdowns in equity and options markets could threaten industry credit ratings around the world, according to Standard & Poor’s. SEC Chairman White ordered exchange owners on Sept. 12 to bolster systems to prevent malfunctions.

‘It’s Frustrating’

“It’s frustrating that these market issues are happening so often lately,” Jon Cherry, senior vice president of derivatives trading at Chicago-based TJM Institutional Services LLC, said in an interview. “It’s across many exchanges, and it’s in options and equities.”

The SEC has questioned the quality of options market oversight, telling Chicago-based Options Clearing Corp. in September that it has “serious concern about systemic weaknesses in OCC’s risk management and operations,” according to a letter obtained by Bloomberg News. The clearinghouse guarantees all trades on U.S. options exchanges. The SEC chastised Chicago-based CBOE in June for an oversight breakdown that resulted in a $6 million fine.

ISE said its technical issue yesterday involved the software configuration in its connection to Opra, according to a statement. A workaround was implemented and “ISE and Opra technology teams are collaborating to restore the proper configuration,” ISE said.

Quote Information

NYSE Euronext (NYX:US)’s Securities Industry Automation Corp. oversees Opra, which administers the dissemination of trade and quote information to brokers, investors and market-data vendors such as Thomson Reuters Corp. and Bloomberg LP, the parent of Bloomberg News. NYSE Euronext spokesman Eric Ryan declined to comment on ISE.

The two U.S. options markets that ISE runs handled a combined 15 percent of the nation’s equity derivatives trading last month, according to data compiled by OCC.

Separately, the Chicago Board Options Exchange Volatility Index, known as the VIX, surged and fell yesterday in a series of bursts that CBOE later attributed to a software flaw.

The spikes in the benchmark measure of U.S. options prices were probably unrelated to the ISE malfunction because CBOE has exclusive rights to options on the Standard & Poor’s 500 Index. Contracts on that equity gauge determine the price of the VIX. (VIX)

The VIX jumped to 21.26 from 13.94 at 10:02 a.m. New York time yesterday. The next price was 13.92. At 11:22 a.m., the VIX posted another temporary spike: up to 15.27 from 14.16, and then immediately back down to 14.17, according to data compiled by Bloomberg. It happened again at 12:19 p.m. with a jump to 19.53 and retreat to 14.31, the data show.

Software Issue

Later, CBOE said on its website that the unusual VIX moves were caused by a “software issue” that was resolved as of 1:21 p.m. New York time yesterday. The VIX ended the day at 13.65 yesterday. Its counterpart in Europe, the VStoxx Index, fell 3.3 percent to 15.62 at 9:36 a.m. in Frankfurt today.

“If you have consistent, repeated incidents of dubious data, then it may cause people to lose confidence,” Randy Frederick, managing director of active trading and derivatives at Charles Schwab Corp., said in a phone interview from Austin, Texas. His firm has about $2.2 trillion of client assets. “Any types of technology glitches cause concern for investors. That’s no question.”

The moves in the VIX didn’t affect pricing of futures and options contracts on the index, said Bouhari Arouna, director of equity trading strategy at Citigroup Global Markets Inc. While the VIX isn’t itself traded, CBOE has created contracts linked to the measure.

‘Not Ideal’

Trading malfunctions have plagued the U.S. stock and options markets since the May 2010 plunge known as the flash crash. This year, Goldman Sachs Group Inc. bombarded options markets in August with unintended orders, some of which were later canceled. On April 25, the CBOE opened for trading 3 1/2 hours late because of a software malfunction.

“It does happen on a fairly regular basis that you get a strange print in the VIX, but the timing of these issues is not ideal for the options market,” said Bill Luby, who trades volatility products as chief investment officer of Tiburon, California-based Luby Asset Management LLC. “We just had the Goldman issue, Nasdaq had a major disruption and CBOE is rolling out extended VIX futures trading hours, so they certainly want to make sure their calculations and software are ready.”

To contact the reporters on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Lynn Thomasson at lthomasson@bloomberg.net


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