Built-In Loop Holes Are The Foundation for Liquidity In Our Markets


The Chicago Mercantile Exchange (CME) is the largest futures exchange in the US. Traditionally the CME has been a crucial place for farmers and food companies to hedge risk, be they in soy, wheat, energy, or hog futures. Today, the CME’s largest customers should be no surprise to you however – they are high frequency traders.

Parallel to the development and evolution of our US stock markets is the development of our derivatives markets. Where for-profit public stock exchanges have given perks, speed, and order-type advantages to HFTs, so have for-profit public futures exchanges. In today’s WSJ Scott Patterson and Jenny Strasberg yet again point out another example: High Speed Traders Exploit Loophole.

The article details a several millisecond advantage that is sold by the CME to the highest bidders – HFTs. And while the CME is eager to point out that anyone can choose to pay their ransom, the reality is that ransom is a cost imposed on other market participants who do not need/want the speed for their strategies/needs; they do not want to pay the exorbitant fees for the privilege of not getting picked off. Think farmers and food companies…

The article is most notable to us because of the flippant and entitled points of view of several high frequency trading firms interviewed in the article:

–          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.

–          Officials with Chicago-based DRW Trading Group see the data-feed lags at CME as a “fact of life,” not an unfair advantage

Incidentally, while proprietary trading firms like Virtu, DRW, and Jump Trading believe they are providing you all a service (narrower spreads) by exploiting such loopholes and extracting billions of dollars from investors, as soon as academic papers that demonstrated their aggressive nature (The Trading Profits of High Frequency Traders and Exploratory Trading) were published using CME data, they used their clout to shelve the academic papers and the CFTC research program’s use of CME customer data.

So CME sells the perks, and if their largest customers object to research that calls them out on their scalping nature, they get the CME to stop providing data for the research.

Loopholes. For-profit exchanges. Nice. Just swell.