Liquidity Panic? A $90 Million Sell Order Crashed China's Futures Market

Seemingly missed by the mainstream media on Monday, Chinese equity futures crashed over 12.5% - the biggest drop since 1995 - only to soar back to unchanged within seconds. This was not a 'fat-finger' trade, and as one trader noted, "liquidity in the market is really thin right now," which is borne out by the evidence. Thanks to government rules disabling "hedging" accounts from holding more than 10 contracts a day, volume (and liquidity) has become practically non-existent since September and so the 12.5% flash crash was driven by just 3 trades totalling just 646 contracts which means a mere $92 million sell order collapsed Chinese equity markets by the most on record.

A shocking move...

But when we zoom in it is apparent that just 3 trades were responsible for the plunge - the initial 398 contract sell, followed by a 107 contract order and a 141 sell all at 22:42:10

As background, we note that a hedging account is a designation for investors who use futures to offset risks from their holdings in the stock market. Such accounts are exempt from limits on opening more than 10 contracts in a day, according to CFFEX rules announced in September... so this could only be a hedging account.

In other words just 646 contracts - or 'hedging' around $92 million notional  - managed to crash the Chinese futures market by the most on record.

And here is why...  Chinese policy makers restricted activity in the futures market last year because selling the contracts is one of the easiest ways for investors to make large wagers against stocks. Volume shrank by more than 90 percent from its peak after officials raised margin requirements, tightened position limits and started a police probe into bearish wagers.

Yes that is the real volume chart.

Some international traders with negative views on Chinese stocks have shifted their wagers to offshore markets. As we noted previously, short interest in Chinese ETFs is now at record highs...


Which could be why Chinese stocks are stubbornly ignoring the collapse of the currency...


As Bloomberg notyes, while sudden price swings are hardly unique to Chinese exchanges, the country’s markets have come under increased scrutiny in recent months as MSCI Inc. considers adding mainland shares to its international indexes. Recent measures to curb trading halts and clarify beneficial ownership rules have improved the country’s odds of inclusion to 70 percent, Goldman Sachs Group Inc. analysts wrote in a report on Tuesday, which was one of the factors behind the market’s rally. MSCI will announce its decision next month... and we are sure a record intra day crash in prices will have no impact on the political decision to bring Chinese equity volatility into the world's biggest benchmarks.