A big mystery seller of futures contracts during the market meltdown last week was not a hedge fund or a high-frequency trader as many have suspected, but money manager Waddell & Reed Financial Inc, according to a document obtained by Reuters.
Waddell on May 6 sold a large order of e-mini contracts during a 20-minute span in which US equities markets plunged, briefly wiping out nearly US$1 trillion in market capital, the internal document from Chicago Mercantile Exchange parent CME Group Inc said.
Regulators and exchange officials quickly focused on Waddell’s sale of 75,000 e-mini contracts, which the document said “superficially appeared to be anomalous activity.”
More than a week after the incident, it was still not clear what impact the unusual trading in the futures contracts had on the broader meltdown in the stock market.
The e-minis are one of the most liquid futures contracts in the world, providing holders exposure to the benchmark Standard & Poor’s 500 Index. The contracts can act as a directional indicator for the underlying stock index.
Waddell manages the US$22.1 billion Ivy Asset Strategy fund, which is well-known for hedging with equity index futures when manager Mike Avery, who is also chief investment officer at the company, feels uneasy about the market.
The Asset Strategy fund has dropped 2.76 percent this quarter, compared with a 0.8 percent decline in the S&P 500, data from Lipper Inc, a unit of Thomson Reuters Corp, show.
Gary Gensler, chairman of the US Commodity Futures Trading Commission, said in congressional testimony on Tuesday that it had found one sale that was responsible for about 9 percent of the volume in e-minis during the sell-off in the US markets.
Gensler said there was no suggestion that the trader, whom he did not identify, did anything wrong in only entering orders to sell. Gensler said data showed that the trades appeared to be part of a bona fide hedging strategy.
It is unclear what impact the trading in the e-minis had on stock prices during the plunge, but regulators have scrutinized futures trading because the sharp decline in that market preceded the dive in the broader US equities market.
The document said that during the sell-off and subsequent rally, other active traders in e-minis included Jump Trading, Goldman Sachs Group Inc, Interactive Brokers Group Inc , JPMorgan Chase & Co and Citadel Group.
During the 20-minute period, 842,514 contracts in e-minis were traded. The CME document did not provide a break-out of Waddell’s trading during that crucial time, but said from 2pm to 3pm EDT it traded 75,000 contracts.
Overland Park, Kansas-based Waddell declined to return calls seeking comment. But in a statement, the company said: “Like many market participants, Waddell & Reed was affected negatively by the market activity of May 6.”
Waddell said in its statement that it often uses futures trading to “protect fund investors from downside risk,” and on May 6 it executed several trading strategies including the use of index futures contracts as part of normal operations.
The notional value of the contracts sold by Waddell was US$4.2 billion, according to the document. How much Waddell paid for the contracts was not stated, but typically the cost would be far less than their notional value.
The company, which advises and distributes the Ivy Funds, has made a name with good results from its family of mutual funds.
Waddell’s shares fell after the Reuters report, and closed down 5.3 percent at US$32.25. Volume was 1.28 million shares, more than triple the daily average this year.
Trading in e-minis takes place entirely on the CME’s Globex exchange. Hedge funds and high-speed trading firms often use the e-mini in an arbitrage strategy that seeks to capture the change in prices between the futures contract and the S&P 500.
Waddell’s contracts were executed at Barclays Plc’s Barclays Capital and later given up to Morgan Stanley, according to the document.
CME said it spoke to representatives from both banks on May 6 and planned to speak to Waddell representatives the following day. The firm oversaw US$74.2 billion in assets as of March 31.
Gensler said the contracts were sold between 2:32pm and 2:51pm on May 6, the height of the meltdown.
The market for e-minis on May 6 fell more than 5 percent in a little more than five minutes starting at 2:40pm — the height of the crash, the document said. The e-minis began to recover before stock prices turned higher.
An order the size of the Waddell contract would be a big trade to execute on a normal day, said a trader whose firm is active in the S&P 500 futures market. About 50,000 contracts are typically traded in an hour, the trader said.
“To get rid of 75,000 contracts, that’s a lot of trading even if the market is healthy,” the trader said. “But when suddenly the market changes and there’s not as many bids there to trade with, 75,000 is going to cause quite a shock to the market.
“That’s an enormous position for anybody, whether it’s a hedge or whether it’s a trade. It’s a big position, no doubt about it,” the trader said.
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