The Flash Crash that Caused the Flash Crash?

Michael Gayed of Pension Partners has a thought-provoking piece up on Seeking Alpha. The topic: a pattern he found that shows a smaller “flash crash” in one proxy for high yield junk debt preceded the larger equity free fall May 6.



The recent report by the Securities and Exchange Commission on that equities “flash crash” lays blame on the combination of a jittery market and a mutual fund company that moved to sell $4 billion in futures contracts, which pushed prices lower.   News sources have identified the firm as Waddell & Reed.

Though the SEC compared the stock and stock futures markets, there’s no discussion of fixed income markets’ behavior that day.

Gayed argues that there may have been something else contributing, particularly a delayed response to bond investor skittishness. He cites the  following chart.

The chart on top is a 1 minute price chart on the S&P 500 ETF (Symbol: SPY), while the bottom chart shows what the price action of the SPDR High Yield Junk Debt ETF (Symbol: JNK) was during the exact same time period. In a span of 10 minutes, JNK dropped from peak to trough about 6% (a substantial decline given the volatility characteristics of Junk Debt on average). The SPY ETF in a span of 10 minutes dropped roughly 7%. But this was NOT during the same 10 minutes.

What caused this fast movement down and up in debt yields?

Are these events related?

In an interconnected financial world, those seem like important questions.

Especially since the SEC’s explanation has drawn some criticism — most notably from data firm Nanex that mapped Waddell’s trades looking for evidence of its role and found less connection to the market’s overall moves than would be expected. (Waddell supplied that data, though it was confirmed by another party, Barclays, which also has business dealings with Waddell.)

According to Nanex:

the W&R trades do not appear to be near the point we believe is the ignition point at 14:42:44:075. Furthermore, the W&R trades are practically absent during the torrential sell-off that began at 14:44:20. The bulk of the W&R trades occurred after the market bottomed and was rocketing higher — a point in time that the SEC report tells us the market was out of liquidity.

2 thoughts on “The Flash Crash that Caused the Flash Crash?

  1. Sean Murphy

    a few reports also mention a way out of the money put purchase in the S & P 500 (50,000 options) prior to the large emini sale. Why isn’t this mentioned in most discussions? Better yet, evidently the purchaser was anticipating a large drop within a month, as the put strike was equivalent to the S$P trading 800. What did the purchaser know??? For sure there is way more to the story than what the SEC is focusing on, as you point out in the JNK chart.

  2. Michael A. Gayed, CFA

    Sean,
    The firm you’re referring to makes bets on “Black Swan” events, i.e. low probability, high impact events. While there are theories that argue that the put options could have also triggered the crash, the trade was put on because yields were exploding higher before equities collapsed. The decline in Junk debt was substantial adjusted for historical volatility and a significant event, and yet there seems to be no focus on that asset class.

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