Grand Theft Market: High-Frequency Frontrunning CME Edition

Tyler Durden's picture

One of the New Normal responses to allegations, first started here in 2009 and subsequently everywhere, that all HFT does is to frontrun traditional market players (among many other evils) now that its conventional and flawed defense that it "provides liquidity" lies dead and buried, is that "everyone does it" so you must acquit because how can you possibly prosecute a technology that accounts for over 60% of all market volume and where if you throw one person in jail you would throw everyone in jail. Today we learn that this indeed may be the case, and not only at the traditional locus of HFT frontrunning such as conventional exchanges for stocks such as the NYSE or even dark pools, but at the heart of the biggest futures exchange in the US, the CME where as the WSJ's Scott Patterson explains frontrunning by HFT algos is not only a way of life, but is perfectly accepted and even smiled upon.

Stop us when all of this sounds familiar.

High-speed traders are using a hidden facet of the Chicago Mercantile Exchange's computer system to trade on the direction of the futures market before other investors get the same information.


Using powerful computers, high-speed traders are trying to profit from their ability to detect when their own orders for certain commodities are executed a fraction of a second before the rest of the market sees that data, traders say.


The advantage often is just one to 10 milliseconds, according to people familiar with the matter and trading records reviewed by The Wall Street Journal. But that is plenty of time for computer-driven traders, who say they can structure their orders so that the confirmations tip which direction prices for crude oil, corn and other commodities are moving. A millisecond is one-thousandth of a second.


The ability to exploit such small time gaps raises questions about transparency and fairness amid the computer-driven, rapid-fire trading that increasingly grips Wall Street and confounds regulators.

Well, for there to be questions about "transparency" and "fairness" one's underlying assumption must be that they exist. Luckily, courtesy of 4+ years of constantly broken markets, in which regulators jawbone and talk about fixing everything any day now, but nothing ever changes, because why change -  a rising manipulated tide lifts all boats (some more so than others) until it all crashes of course - nobody harbors even the faintest illusion that the stock and futures market casino is any less rigged than the shadiest Las Vegas backdoor operation.

What is more troubling is that while HFT had historically been relegated to such non-reflexive asset classes as stocks, now that it has entered the hyper-levered derivative and futures arena, all bets are off. Recall: "The Chicago Mercantile Exchange, a unit of CME Group Inc., is the largest U.S. futures exchange, handling 12.5 million contracts a day on average in the first quarter, according to Sandler + O'Neill Partners L.P. High-frequency trading generated about 61% of all futures-market volume, up from 47% in 2008, according to Tabb Group."

For those who are unfamiliar with how HFT frontruns everything here is a quick breakdown:

Fast-moving traders can get a head start in looking at key information because they connect directly to the exchange's computers, giving them the data just before it reaches the so-called public tape accessible to everyone else. The exchange connections contain a host of data, of which the advance notice of trade confirmations is only a piece.


All firms that connect directly to CME's trading computers are able to get information ahead of the market when their trades are executed, firm officials say. But many companies are unaware of the advantage or choose not to use it, traders say, either because they don't have the technology to take advantage of such tiny edges or employ different investing strategies.


CME spokeswoman Anita Liskey said the exchange operator is aware of the order delays, which industry officials refer to as a "latency."

Others call it bare-faced robbery, or better yet Grand Theft Markets. And nobody cares. Actually, that's not true. Those w

While many speed advantages are well-known to market insiders, only a relatively small group of sophisticated firms appears to be aware of the CME's trade-reporting delays. The CME has told regulators that investors routinely get trade information at the same time. A March 29, 2012, CME presentation to the CFTC stated that market data "is disseminated to all participants simultaneously."


A Chicago trading firm says it recently detected delays between the time it received confirmations of trades and the time the CME published the information on multiple futures contracts covering thousands of trades. For two weeks in late December and early January, the firm detected an average delay of 2.4 milliseconds for silver futures, 4.1 milliseconds in soybean futures and 1.1 milliseconds for gold futures.


Sophisticated traders have been aware of CME's order-latency issue for years and have incorporated the information into their trading strategies, according to an official with Jump Trading LLC, a big Chicago high-frequency company.


Officials with Virtu Financial LLC, a high-speed trading firm in New York, view a slight head start as good for the overall market, according to a person familiar with their thinking. The person said the data helps traders who buy and sell futures contracts throughout the day manage risk and post more quotes that benefit other buyers and sellers. The person said Virtu doesn't use the information to amplify its profits by anticipating moves elsewhere in the market.

If you are not laughing hysterically here, you are not paying attention.

Proponents say eliminating the ability of parties in a trade to get information slightly in advance could lead to less-liquid markets because some firms would be inclined to trade less due to the greater risks.


Officials with Chicago-based DRW Trading Group see the data-feed lags at CME as a "fact of life," not an unfair advantage, because any firm trading in milliseconds can take advantage of it if they build their systems properly, according to a person familiar with their views.


Firms can use their early looks at CME trading data in several ways. One strategy is to post buy and sell orders a few pennies from where the market is trading and wait until one of the orders is executed. If crude oil is selling for $90 on the CME, a firm might post an order to sell one contract for $90.03 and a buy order for $89.97.


If the sell order suddenly hits, the firm's computers detect that oil prices have swung higher. Those computers can instantly buy more of the same contract before other traders are even aware of the first move.

Then of course there is cross exchange latency arbitrage, a topic we first discussed in, oh... 2009.

Firms can also capitalize on that early information by buying a related product on another exchange before other traders know of a market shift. For example, it takes about 200 microseconds for trades to get from CME's Aurora, Ill., data center to the computers of IntercontinentalExchange Inc. ICE +1.12% about 33 miles away. A microsecond is one-millionth of a second.


Traders able to see market swings milliseconds before others gives them "an informational advantage," says Pete Kyle, a finance professor at the University of Maryland who is a former member of the Commodity Futures Trading Commission's Technology Advisory Committee.


Mr. Kyle likened the activity to "a tax on other traders" because "you get all the gains from being the first guy" to trade.


The CFTC, which oversees futures exchanges such as the CME, has been ramping up oversight of high-speed trading but agency officials said the CME'S latency issue isn't currently an area of focus.

Have a problem with this latest feature of openly broken markets? Tough. Get in line. Else, just submit your order but expect to be routinely ripped off to the tune of pennies on every trade. Now multiply this by millions of times evry hour, for four years. It adds up.

No wonder it's called the wealth effect. Effect for you. Wealth for them.

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fonzannoon's picture

For anyone who has not seen it. This was a great description of how algo's are literally shaping the world.

DaveyJones's picture

I never knew free markets meant free for some people

Dollar Bill Hiccup's picture

And THAT concludes our morning market simulacrum. Time to head back to green.

Dr. Strangelove could do no better.

Divided States of America's picture

Yup down 78 on the Dow today was the buying opp today...much like yesterday. Sorry, you guys missed out again.

As for whether Virtu financial profits from all these sneaky tactics, thats easy to find out. just ask someone who used to work there and left on a bad note or check out the employees who work there and see if they are driving lamborghinis/maseratis or lexus.

spastic_colon's picture

as Cramer would explain...."tickling the futures".....but it's perfectly legal of course  /s


we'll know the party is almost over when the first HFT company IPO is announced

Urban Roman's picture

Didn't they try to launch one last year only to be shorted into oblivion seconds after it went 'live'? 

spastic_colon's picture

yep you're right...i only have algo time memory

kdrury12's picture

that already happened when Getco bought Knight, thus going public via reverse merger

youngman's picture

You know it is being smiled upon...they donate big amounts of money to Politicians....its called liquidity....

kdrury12's picture

yes, by definition, to avail youself of the benefit described in the article, you had to have been providing liquidity on CME

madbraz's picture

Criminals, criminals.  But then again, Eric Holder has more important things to do - like going after Obama's right hand man Corzine.  Oh wait...

ebworthen's picture

Yeah, Holder is having a hard time getting a lunch date with Corzine - Holder will pay with his D.O.J. credit card.

Cognitive Dissonance's picture

Legalized (market) theft same as it always was. The only difference between today and 20-30-50 years ago is that it now happens on a millisecond basis.

Markets don't move, they are moved. And that's the way it's always been.

DaveyJones's picture

The song remains the same but the guitars are bigger. And just like the speed, size and scope, so goes the collapse... 

actually, I think the song is sadder, sicker and slicker. An innevitable point in limited physical resource and a bloated and corrupt system that is the farthest thing from representing it.

Bananamerican's picture

Thou canst serve both God and Mammon

Downtoolong's picture

True. But, whereas a floor trader could once only blow himself up, an algo can now potentially blow up the entire financial world. What's been lost in the shift to automation are true market makers (specialists) to maintain trade protocols in the HFT realm. We now only have predators preying on investors any and every way they can imagine without limits.

Cognitive Dissonance's picture

But....but....but they provide vital liquidity bro. :)

<Don't pee on me bro.>

DaveyJones's picture

exactly  and in the meantime, they got us afraid of foreigners with fireworks

Tunga's picture

You mean the chap with the thermonuclear device under his arm? 

Tunga's picture

Which just goes to show why "limited slip differential" was named "Posi traction" instead of LSD. 
Just saying.  

ebworthen's picture

Holy Hannah!  Look at Gold plummeting this A.M.!

Perchance, someone got word of something different coming from the FED?

A $30 drop in a little over an hour?  Something is bubbling and roiling under the surface here.

jimmytorpedo's picture

CME president says "gold coins are good"

Therefore price goes down.

Aren't you on board with the new normal?

Buy now because the price will go down shortly.

RaceToTheBottom's picture

Gold says "I spit on thee".

Schmuck Raker's picture

CME response (a portion anyway;via The Fly):

CME Group reponds to WSJ article
CME Group released the following statement in response to today's Wall Street Journal article:

"While there can be instances of inconsistencies with any technology, CME Group is continually making improvements to our trading platform to increase efficiencies, including variability between the time a firm or customer receives its trade confirmation and it appears on the public data feed. Out of the more than 300 million messages that come into our platform each day, there may be times when customers can experience a latency of a few milliseconds between the time they receive their trade confirmations and when that information is accessible on the public feed. However, these instances are not consistent and vary across asset classes. At CME Group, our goal is to bring variability as close to zero as possible and we have made significant steps to address latencies related to trade confirmations. At the end of last year, we strengthened the overall performance of our CME Globex trading platform by reducing order response times and limiting variability within and across asset classes. In the first quarter of 2013, we upgraded our match-engine hardware. Through the remainder of this year, we will be implementing additional hardware, software and architectural upgrades – all designed to further reduce potential discrepancies in processing times, make the overall system performance more predictable, and enhance the CME Globex trading experience for our customers."


Exec summary: "Nothing to see here. Blah, blah, blah..."

Cognitive Dissonance's picture

A classic amoral response.

"We don't determine if the overall system is slanted towards or favors one group over another (i.e. HFT over the eTrade baby) because that is someone else's responsibility. We simply attempt to make the system even among those who actually pay our bills (i.e. HFT)."

Translation? We also dance while the music plays. Even if we are the DJ's turntable.

DaveyJones's picture

"instances of inconsistencies with any technology"

criminals, when caught, will often use very abstract nouns and verbs to describe their behavior,  in an attempt to distance themselves

it is the chosen language of lawyers and politicans

Cognitive Dissonance's picture

As do those charged with policing the criminals, but who do not for various reasons........usually due to glaring conflicts of interest.....theirs vs. yours and mine.

Bananamerican's picture

In that TED talk link above, he mentions Spreadnetworks 825 mile fiber optic cable being laid between the NY and Chicago exchanges...several years in the works....
Vast infrastructure projects like this require an era of regulatory.....Certainty.

....all the better to eat you with my dear

Gypsyducks's picture

These instances happen consistently, at least once a week.  Orders are submitted, the CME's servers are overloaded and I receive trade confirmations milliseconds after I have submitted a modified order.  They love to sweep the options about 1 millisecond before they take all of the futures for ten ticks.  Definitely encourages me to trade more when i can give up a half day's work in 4 milliseconds....  HFT is great!

mattdubz86's picture

The fed's traders and bullion banks got all the macro data releases pre-market

McMolotov's picture

I miss the days when fake orange crop reports moved markets.

Its Only Rock N Roll's picture

Pork bellies...I have a hunch something exciting is going to happen

ParkAveFlasher's picture

HFT advocates always complain how less HFT would mean lower liquidity and fewer trades, like it's a bad thing.  This is like a den of car thieves complaining that bridge & highway toll revenue will drop if they aren't allowed the getaway.  This is like a mass murderer complaining about how many FBI agents would be jobless without him.  This is like cancer complaining about how many manufactured coffins it will no longer be able to fill.  This is a plague of locusts that blots the sun advocating that they are a net global coolant.

DaveyJones's picture

great analogies

unfortunately, that's exactly how our medical and criminal justice systems work

buzzsaw99's picture

Look at it as a vat tax for fat cats.

buzzsaw99's picture

see algo run

run algo run

see algo jump

jump algo jump...

22winmag's picture

Break out the handcuffs and orange jumpsuits. If the legal system and the military won't perform the grand smackdown, the people will.

optionsman's picture

no they won't. the people are too concerned with Honey Boo Boo type shows. military- seriously? Legal system? not for the grand theft type entrepreners............

Bananamerican's picture

The People's smack down will consist of looted walmarts

DaveyJones's picture

grand theft, grand casino, grand marshals, grand canyons, grandchildren

none of it looks good

The Dancer's picture

Now that corruption is arrogantly sticking it's middle finger up our ass on a daily basis tells me the reset button is not too too far away....absolute corruption is on parade front and center. Where, oh, where is a courageous leader to take the people by the hand and tell them the bad news and then unite them in the restructure of the brokennpieces of Amerika....personally, I hope every crooked pension fund manager get's the death penality for their sins and mismanagement.

rehypothecator's picture

Congress could shut down HFT in an instant - if they wanted to.  Specifically, they could have special short-term tax rates, like 50% or 99%, for "assets held less than one second" or "assets held less than one microsecond."  But they don't.  That is not their function.  Their function is to enact laws that protect the elites from those they plunder.  

DaveyJones's picture

There goes that annoying fact. There's a lot of things Congress could do. 

rehypothecator's picture

While I am as amenable to having Congress restrict itself to protecting life, liberty, and property as anyone, the fact remains that they enact myriads of laws that do otherwise for the bulk of we peasants, while they let the elites skate.  They even exempt themselves from such things as insider trading and Obamacare.  Within minutes of the Sandy Hook massacre they were talking about constraining the rights of people who had nothing to do with it, while, meanwhile, HFT has been in the news for years and they haven't lifted a finger.  The conclusion is inescapable that they have zero desire to bring any consequence to those who profit from HFT (i.e. at the expense of the peasants).  

rosiescenario's picture

Well if Congress did that someone might then suggest that its members and aides not be allowed to trade on inside information....

How much was it Hilary made on her commodity trades?

The chosen operate under different rules and different rule enforcement than the public.

FiatFapper's picture

If retail traders are found to be using latency arbitrage, they'll freeze your account and take all your profits.