Guest Post: "Pirates, Arbitrage and The Silver Flash Crash", by Viking Analytics

50
Sun, Jul 9, 2017 - 3:25pm

Our friends and subscribers at Viking Analytics have written an interesting article regarding last week's sudden, 10% drop in the price of Comex Digital Silver.

Most everyone here at TFMR saw or heard about the "flash crash" in Comex Silver that occurred at 7:06 EDT last Thursday evening. With theories abounding as to how and why it happened, we thought we'd post this commentary for discussion.

TF

"Pirates, Arbitrage and The Silver Flash Crash"

by, Viking Analytics

One of the quotes that guides my investment and trading philosophy is attributed to Benjamin Graham:

In the short run, the market is a voting machine. In the long run, it is a weighing machine.

- Benjamin Graham

I usually think about this quote with the second sentence in mind. “In the long run, the market is a weighing machine.” As such, I look for occasions when commodities and stocks have diverged from fundamental or benchmark values. After a 25-year career in energy and commodities, I look for ways to profit from those fundamental divergences. But, that is a topic for another article.

In this article, I want to focus on the first sentence: “in the short run, the market is a voting machine.” I believe that this sentence provides some insight into the recent "flash crashes" that we have seen in tech stocks, gold and most recently, silver.

Here is the one of the problems with the “voting machine” market in the short-run: there are entities who have the ability to stuff the ballot box and profit from nano-second moves in the markets. Perhaps especially during times of limited liquidity, the market "voting machine" can easily become an "arbitrage machine."

Silver Flash Crash

As has been widely reported, the COMEX silver market (owned and operated by CME Group) "flash crashed" from a high of $16.07 to a low of $14.34 before recovering to close at $15.90 over a 5 minute trading block of 8,000 contracts. These 8,000 contracts amount to 40 million notional ounces of silver, which is 4.4% of annual mine supply traded in 5 minutes!

Source: TradingView

Becoming a Pirate

One of my favorite quotes from film comes in one of the modern renditions of Peter Pan in the movie Hook. Peter Pan (played by Robin Williams) has left Never-land, and has become a swashbuckling investment banker. Wendy, now much older, goes to Peter Pan to let him know that he is needed in Never-land to once again battle the pirates. Upon seeing Peter’s newfound enthusiasm for profiteering at the expense of others, Wendy is astonished. She says, “why Peter, you’ve become a pirate!”

While I have not become a pirate, I have found that it can be occasionally profitable to think like one. In a game theory analysis of the commodity markets, I try to think like a pirate would think.

If I Were A Pirate . . .

Before we get to our pirate flash crash strategy, let's look at a recent bid-offer stack for the iShares Silver Trust (SLV). In this example, there are almost 400,000 bids to buy SLV at 14.91, and almost 110,000 offers to sell SLV at 14.92. We can see bids and offers above and below these levels. Most retail investors have the ability to see this bid-offer stack in the stock markets, and the same kind of bid-offer stack exists in the futures markets.

Source: E-trade

If I were a pirate (I am not), having the means to do so (I don't), I would evaluate the bid-offer stack of my target commodity, and during times of illiquidity (like 4am EST on a Monday, or 7pm EST on a Thursday), I would set up limit purchase orders 5% to 10% below the current price (for example), and then place a sell order that hits every bid in the bid stack. At key technical trading levels, I will have the added benefit of triggering known and unknown stop loss orders.

The cascading effect of the flash sale, combined with the known and unknown stop loss sale orders (designed to protect long positions and/or profit from a new downtrend) would ideally cause price to decline to the place that I had established my purchase orders. In my perfect pirate world, the short orders that I had created to hit every bid would be covered by the purchase limit orders that I had created below.

This pirate activity can of course be optimized by HFT algorithmic computers that have a form of market price omniscience, being fed continuously with the bids and offers, and oftentimes the stop loss data as well.

Five minutes later, price recovers almost to where it was before, and I would have arbitraged the bid-offer stack, making millions from my market omniscience in an illiquid market. I am not a lawyer, and I have no comment on the legality of this activity. I can only assume that the activity is legal, but perhaps represents a serious market inefficiency.

Who Loses In This Flash Crash?

The losers from the flash crash are the retail and other investors who do not have the same level of information and market-moving ability as others, and who have attempted to protect their long positions with stop-loss orders.

I have copied a couple of tweets from this morning that elaborate on this point. First of all, I must say that I am impressed that CME Group responded quickly to adjust and correct some of the orders made during the flash crash period. Whether CME was “fair” in the allocation of fills is not for me to decide.

One trader reported that he had a long position in silver futures, and had established a protective stop loss order at .80/oz. Unfortunately, stop loss orders are sometimes only triggered if there is an actual bid or offer at the exact level of the stop loss order. In this case, the trader’s stop loss order was not filled at .80 because liquidity in the market had vanished when the bid-offer stack was raided. When the market adjusted a nano-second later, the next quoted bid was used to fill his stop loss order with a sell at .00. As a result, his protective stop loss order was originally __spamspan_img_placeholder__.80/oz lower than what he had set. An __spamspan_img_placeholder__.80/oz loss on one futures contract in silver is worth ,000.

Fortunately for this investor, CME Group corrected adjusted his order to a stop loss at .56, so he only lost __spamspan_img_placeholder__.24/oz more than he had anticipated with his original stop order. But that __spamspan_img_placeholder__.24 still amounts to ,200 lost in a nano-second on a single futures contract.

After the dust had settled five minutes later, if this trader had not had the protective stop order of .80, he would have retained his long contract at a value of .90. In this case, the retail investor was easily fleeced by a 5 minute down-up spike in the price of silver.

Applications

We have attempted to alert readers to this kind of activity before, but it is of course complex and takes some contemplation to follow along. This example above is a more detailed example of what I attempted to explain in one of my prior articles: Trading JNUG and NUGT? Play Blackjack Instead.

Because this kind of stop-running activity can occur in all markets, in my trading I try to focus on the end-of-day closing price and set mental stops, not actual stop loss orders. This requires more screen time and discipline. During times of high liquidity, stop loss orders might be good to have. However, it is important for retail investors to know that some or most of their stop loss order data is sold to firms who have the ability to profit from that information.

Finally, thinking like a pirate helps me to understand where the pirates might be steering the pirate ship. I ask myself, “if I had vast resources and more perfect information, how could I arbitrage the market tomorrow, next week or next month?” I am currently studying the very deep and influential options markets in COMEX gold and NYMEX crude oil, and have developed tools to calculate where the “sweet spots” or “price magnets” are located. If I were a pirate, I would seek to capitalize on the fear and greed that I can induce into these markets, and sell volatility at key support and resistance areas. But, that’s just me.

I share this kind of research with my Seeking Alpha subscribers, as we seek to navigate the rocky shoals of these markets together, and hopefully avoid the pirate ships along the way.

About the Author

Founder
tfmetalsreport [at] gmail [dot] com ()

  50 Comments

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Bohemian
Jul 11, 2017 - 6:08pm

@AGXIIK

You see...? ;-) I can be used for a diversion? I can confuse the enemy.

AGXIIK
Jul 11, 2017 - 9:28am

Bohemian Fear not There's a place for you too

Maybe walk point with a 12 GA shotgun. Your wife will appreciate that since it gets you out of the house. That's what my wife tells me and yes, she thinks I'm a genius too.

Bohemian
Jul 11, 2017 - 2:58am

I am not a Pirate :-(((

-- but I have some skills? ;-) Will you take me? I can drive some people nuts! My wife says that I am a genius. And my wife knows what she's talking about.

NW VIEWAGXIIK
Jul 11, 2017 - 1:01am

AGXIIK

Just moving does not always work out well. Abram and Lot had their problems (Gen. 13) and Lot headed down to the plains of Jordan, including Sodom. Things just seem to degenerate, even when we land in a new nation, a new city, a new land. Who would have thought, in the past, that they would need to protect themselves from all forms of government? Our state and nation is slowly becoming Sodom.

AGXIIK
Jul 11, 2017 - 12:14am

My parents and grand parents would crap the bed over

what we see today It's not that we take it for granted---none of us who is aware and conscious.

Your family's immigration from the Ukraine was before the holodomor but as far as continental genocide, there were bloodbaths everywhere. One line of my dad's family lost 3 of 4 brothers to WWI To close for comfort. One more brother and that side of the family would have died out without a single man to carry on the line.

Which brings me to a subject that most people never talk about

From the git go back tens of thousands of years ago, the human species is not one for family line continuity. In the last 10,000 years or so, only about 5,000 families can say they remained intact Meaning that of all the families alive 10,000 years ago, and there were many, most did not survive. DNA testiing shows this necking down of the human species DNA over the last 10 millenium

So who made it.

Not the luck of the draw. It was those who got out of Dodge before some demented SOB decided to kill every person in a village or city, right down to the infants. Kind of like a lion who kills the offspring of another alpha male's pride to bring the females back into heat and thus is able to pass on his DNA

The lives of the average person, given that until no more than 200 years ago or so 90% of people were slaves, indentured servants or serfs in total bondage to their lords and owners, the chances of a family line surviving and unbroken for 10,000 years was very slim. One of my father's lines goes back to the very earliest times of Ireland and its kings. His family were tough people, able to get a latchhold on life by being faster, harder and smarter than most, moving up in the work of soldiering or merchants, with a few marrying into minor royalty in England, Ireland and Spain Another line can be traced back to Gaul around 3,500 years ago by the name attached to the family. My hopes have been that some of my ancestors were giving Caesar and the Romans Holy Hell. Gaul was never conquered

It was not what you knew but who you knew that saved a family from certain extinction if everything blew up. Just as the lion kills the other bloodlines, the princes, potentates, pharoahs, presidents, poohbahs etc usually got first dibs on who lived and who died helped along with a little Prima Nocte The Scots were not happy about that at all.

We got lucky that our families made it through whatever firewalk was needed to get to the promised land Nowadays I fear for the continuity of the new generations. They remind me of Eloi waiting for the siren, with Morlocks coming for the harvest

It's hard to figure out who you'll fight for if it comes to that--as is apparent in dozens of countries that are still in the Zone of War. I guess I'll figure that out when the time comes. Thing is, I think it will be in my lifetime and I'll probably end up as cannon fodder. We'll see

That's not being depressing --just a fact. I'm not as fast as I used to be or as strong so as a fighting man I'd be off a step or two from my prime. But what the heck, give me a good firing position, a shit load of good ammo and a few rifles, maybe enfilade and a bit of high ground and I'll be accounted for. Just saying,but this is what my friends and I train for---and train others for same.

Since this is a precious metals site---one of the best ways to keep your family alive is wearable wealth---gold sewn into the lining of the coat and some yellow jingle change in the pockets

NW VIEWAGXIIK
Jul 10, 2017 - 11:35pm

@ AGXIIK, It is a slow night!

It does take some guts to open up about our lives. You have picked up some wisdom along the pathway. I grew up surrounded by grandparents who snuck out of the pre-WW1 battlefields in the Ukraine. A family who just wanted to grow a garden, plant some fruit trees, milk their cow, have a pig pen and chicken house and raise their family. Grandma had eleven kids. They really wanted true freedom, a freedom from war and death, a freedom that they thought could be obtained in the "Land of the Free". Our relatives who came through Ellis Island, long ago, paid a huge price for us and we really do not understand what they endured. We are very soft these days and have lost almost all of our freedoms. Oh what would grandma say about today? Jim

AGXIIK
Jul 10, 2017 - 11:18pm

Most people don't know this about me NW VIEW

I have not a single strand of peaceful DNA in my body. Every ancestor was decendant from warriors including father, mother, both family lines going back literally 3,500 years. MY avatar on Silver Doctors kind of says it all.

with this in mind, you might call me kind of a heathen Not much of a follower of any religion but raised in the Church of England back in the day when I lived in Canada I'm comfortable with just about any religion or follower so one's beliefs done get me wrapped around the axle. No sense in criticizing a man's religion. All that does is trash his own vision of a pathway to heaven

This is also not to say I'm itching for a fight but every day someone or something comes along that chaps my hind end My prepping is not legendary by any means but I have close friends who are the uber preppers. So all in all if the crap hits the fan we are all about 30 second from going Full On Berserker: Thanks my Viking father's great grandfather's contribution to the fighting family DNA

My mother's side of the family, coincidentally, were nicknamed The Fighting Craigs. Around the late 1,300's some of the clan got crossways with the local lairds of the fief or maybe the crown and hopped over to Ireland and set up camp

From what I read and heard from family lore, even there they were unable to play nice with the locals, so immigrated to Arkansas where they became typical farmers and regular pains in the ass to the locals. Kind of a theme there too.

My family members where some of the most unpleasant and obnoxious people you'd never want to meet They got run out their home town around 1931 and have been unwelcome pretty much wherever they landed since then. My mother was the only one with good enough sense to put 2000 between them and us. Even so, the family attributed remained. I do not stay in touch with the clan for good reason.

I think I'm the first generation of Craigs who could actually live in polite company without pissing off everyone in the neighborhood. My wife is Scot Irish so we get along just fine She knows where I sleep and let's me know if I get out of line I can expect bad results. And she's far more dangerous than me

More than anyone probably wanted to know about my family.

I have to wonder where Craig Hemke's family originated from My familys last name is Craig but I ended up the with first name of Craig.

My litmus test for friendship is someone who'll go and fight the same war with me. Of course, we'd be on the same side. Mostly.

RickshawETF That's a nice version of the Grosse Messer. I like it because it can wielded single handed But it's best used two handed. Ditto for the Two handed sword That monster was more favored by the Norsemen and really large fighting men who acted as the shock troops and could mow down men on horses as well as smaller units of little men like cutting wheat

NW VIEWAGXIIK
Jul 10, 2017 - 6:25pm

@ AGXIIK_ It is a battlefield, even today!

Well, I am also a fan of a certain kind of Sword. Some believe that we are all to be "passive" in this world and there are times to sit and times to swing the sword. He who has the best skills and weapons usually wins the battle. Yes I know this is not the T.O.F. forum so I will make this short. Spurgeon said some good stuff:

The Sword of the Spirit

April 19th, 1891
by
C. H. SPURGEON
(1834-1892)

"Take the sword of the Spirit, which is the word of God."—Ephesians 6:17.

To be a Christian is to be a warrior. The good soldier of Jesus Christ must not expect to find ease in this world: it is a battle-field. Neither must he reckon upon the friendship of the world; for that would be enmity against God. His occupation is war. As he puts on piece by piece of the panoply provided for him, he may wisely say to himself, "This warns me of danger; this prepares me for warfare; this prophesies opposition."

Difficulties meet us even in standing our ground; for the apostle, two or three times, bids us—"Stand." In the rush of the fight, men are apt to be carried off their legs. If they can keep their footing, they will be victorious; but if they are borne down by the rush of their adversaries, everything is lost. You are to put on the heavenly armor in order that you may stand; and you will need it to maintain the position in which your Captain has placed you. If even to stand requires all this care, judge ye what the warfare must be! The apostle also speaks of withstanding as well as standing. We are not merely to defend, but also to assail. It is not enough that you are not conquered; you have to conquer: and hence we find, that we are to take, not only a helmet to protect the head, but also a sword, with which to annoy the foe. Ours, therefore, is a stern conflict, standing and withstanding; and we shall want all the armor from the divine magazine, all the strength from the mighty God of Jacob.

>>>>>>>>>>>>>>>>>>>

Yes it is a battlefield, but who has the Real Sword and who only has a facsimile? In the day of battle, it is almost impossible to find that which will win the battle and if ones sword is made of rubber, hope that you can run faster then others, looking for a True Weapon. Jim

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RickshawETF
Jul 10, 2017 - 5:48pm

@AIJ

I'm just saying "think outside your box". Antanopolous said [in 2014] blockchain technology is where internet email was in 1992. The only users were those who knew code and technogeeks willing to put in the effort. Ten years later, everybody knew what it was, and it was gaining mainstream acceptance (and use). Ten years after that, Antanopolous' mother was sending him photos of his relatives back in Greece with the swipe of her hand . . .

(He also said that the internet was developed [by the military] as a way for universities to share and collaborate on research. What it ended up being was the largest repository of cat videos on the planet!)

RickshawETF
Jul 10, 2017 - 5:46pm

@AGXIIK

Maybe this one?

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