Grand Theft Market: High-Frequency Frontrunning CME Edition

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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