Observations and Insight

NOTE:  JLN Options will be going on vacation starting Wednesday, December 24.  We will not publish again till January 5, 2014.  We wish all our readers (and everyone else too) a happy and safe holiday.  See you in the new year!


SEFCON Snapshot 2014, Part III: The New Market Structure

The WMBA Americas hosted SEFCON V on November 12, 2014, and John Lothian News was there. We interviewed 14 SEF operators, regulators and participants and put together this three part series on the state of SEFs one year into the mandate.

Part III looks at the new market structure brought about by the creation of SEFs and the regulations that guide them.

While many of the pieces are now in place, this structure is still taking shape, and in some cases, the rules have led to uncertainty and unintended consequences in the market structure.

A key aim of Dodd-Frank and other regulations was increased competition, but is a true “all-to-all” market possible? Is there a cost in terms of liquidity from these and other regulations? Is aggregation of separate liquidity pools a viable option?

Watch the video »

Lead Stories

Volatility Tempests Getting More Common in U.S. Equities
Callie Bost – BloombergBusinessweek
Don’t let last week’s rebound fool you, strategists say. More wild days are coming in the stock market.
While calming words from the Federal Reserve were enough to soothe investors this time, sending the Standard & Poor’s 500 Index to its biggest three-day rally since 2011, equity volatility is picking up and upheavals will become more common next year, according to strategists at JPMorgan Chase & Co. and Bank of America Corp. Three weeks into December, the Chicago Board Options Exchange Volatility Index has already risen 99 percent and fallen 30 percent.
***DA: VVIX has had some hefty spikes lately:  http://www.cboe.com/micro/vvix/

Caught on the wrong side of the ‘vol’ trade
Tracy Alloway – Financial Times
Wall Street already has a reputation for trying to make money on everything. In 2014, investors branched out even further — into betting on nothing happening at all.
Years of low interest rates and unconventional monetary policies undertaken by central banks around the world imbued markets with a sense of somnolence that was hard to shake. Desperate to boost returns, big bond funds, asset managers and even retail punters placed lucrative wagers that markets would stay sleepy and that nothing of significance would happen.
***DA: In this market, though, volatility is like a pimple. Ignore it, and don’t touch it. In a few days it will go away.

U.S. Stocks Little Changed After Rally; Tech vs. Energy
Joseph Ciolli and Jonathan Morgan – Bloomberg
U.S. stocks fluctuated, after the biggest three-day jump since 2011, as gains in technology shares offset the first drop in five days for energy companies.
Facebook Inc. and Intel Corp. rose more than 1.4 percent to pace gains among technology shares. Chevron Corp. lost 1.3 percent as energy companies were the worst performers in the Standard & Poor’s 500 (SPX) Inc. The Nasdaq Biotechnology Index slumped 1.4 percent as Gilead Sciences Inc. sank 11 percent.

Don’t be fooled by market’s volatility
Will Deener – Dallas Morning News
The stock market was afflicted with some bad juju in early December, which was surprising since stocks typically take flight this time of year.
The Dow Jones industrial average was hit by a skein of messy down days during the week of Dec. 8, culminating with a massive 315-point loss — 1.8 percent — on Dec. 12. It has since recovered — 420 points on Thursday — and is up 7 percent for the year.

France shows disdain for unregulated binary options – warns against 155 firms
Andrew Saks-McLeod – LeapRate
Whilst many binary options companies continue to target French citizens as potential clients, French regulatory officials have published a list of some 155 unregulated brands which are promising unrealistic returns whilst not possessing the correct license to operate in France
***DA: So, does that mean there is a license one must obtain in order to promise unrealistic returns in France?

Why You Never Buy and Hold VXX
Adam Warner – Schaeffer’s Investment Research
Remember the iPath S&P 500 VIX Short-Term Futures ETN (VXX)? We haven’t checked on our favorite exchange-traded note (ETN) in quite some time now.
VXX, of course, did quite well recently, albeit for a relatively brief time. It hit all-time intraday and closing lows on Dec. 5, then proceeded to rally 32.5% close-to-close over the next week and a half, before peaking on Dec. 16 at 34.63. And then the market explosion happened, and with it the inevitable VXX implosion: it dropped 16% in three sessions.
***Words of wisdom.

Expect More High-Volatility Days
Sam Collins – InvestorPlace
Stocks advanced again on Friday, and although the gains were relatively small, they capped a week in which the Dow industrials and S&P 500 recorded their biggest two-day percentage gain since 2011. For the S&P 500, it was also the largest weekly gain since October, and the index finished just 0.2% off its closing high.
The catalyst for the blocks of buying that began on Wednesday was the Federal Reserve’s assurance that it “can be patient” regarding an interest rate hike. And the European Central Bank (ECB) indicated that it was prepared to engage in a bond-buying plan in 2015.
***DA: But maybe not this week.

Volatility Update: Santa Rally or Early Vacation for the Big Guy?
JJ Kinahan – Forbes
Whether or not jolly old St. Nicholas delivers presents to Wall Street in 2014 might very well depend on upcoming economic data. That’s because the earnings calendar slows to a crawl.
What’s more, financial markets kill the lights early on Wednesday, and although the equities markets re-open Friday, it’s still an official government holiday—meaning nada on the data front. As a result, the week’s major reports are all front-loaded.

Anatomy of a hoax: how a 17-year-old built a crazy rumour that swept financial media
Jana Kasperkevic and Heidi Moore – The Guardian
A New York Magazine profile of him in the magazine’s “Reasons to Love New York” issue presented him as a financial whiz kid, with a BMW he was not yet old enough to drive and a multimillion-dollar apartment his parents wouldn’t let him move to; a search of his name linked to the word “trading” still returns over 100,000 Google results, including articles in publications as diverse as the Latin Post and E! Online. The fame turned to notoriety fast.
***DA: There was a decimal in the wrong place when reporting his net worth. A mere seven spaces off.


ISE Gemini Introduces Flat Pricing for Price Improvement Auctions
Press Release – International Securities Exchange, LLC
ISE Gemini announced the introduction of a new “flat” pricing structure for price improvement mechanism (PIM) auctions as of January 2, 2015, subject to regulatory clearance. With this new model, both PIM auction initiators and responders will pay the same fee of $0.05 per contract. Priority Customers on the originating side of a PIM order will continue to be free. The new structure will create additional transparency and a more level playing field in auction pricing. It also has the potential to deliver a higher level of price improvement to the end customer by increasing competition among auction responders at a fee level substantially lower than competing auction mechanisms.
***DA: Beauty in simplicity.

ICE Has Unlikely Ally on Trading Proposal
Bradley Hope – WSJ
Jeffrey Sprecher, chief executive of Intercontinental Exchange Inc., recruited an unlikely ally in his efforts to revamp the U.S. stock market and bring more trading back onto exchanges.
Among the first public backers of what observers have called ICE’s “grand bargain” with Wall Street is Credit Suisse Group AG , whose executives have sparred with stock-exchange operators over the impact of off-exchange trading venues.

CBOE and C2 enter into Agreements with Finra Involving Regulatory Services
Press Release – CBOE
CBOE Holdings, Inc. (NASDAQ: CBOE) today announced that Chicago Board Options Exchange (CBOE) and C2 Options Exchange (C2) have entered into an agreement with the Financial Industry Regulatory Authority (FINRA), under which FINRA will perform the majority of the exchanges’ regulatory services.
***DA: A sensible split between regulatory and business oversight. And it sounds like most staffers will continue in their current capacity, just under a different SRO umbrella.

Regulation and Enforcement

Volcker Criticizes Delay To Namesake Rule
MoneyBeat – WSJ
Paul Volcker isn’t happy with delays to provisions of an eponymous rule that forces banks to pull out of certain risky investments.
The former Federal Reserve chairman sharply criticized the Fed’s decision to give banks until 2017 to sell stakes in private-equity, venture-capital and hedge funds covered by the “Volcker rule,” a key plank of the 2010 Dodd-Frank financial law. The rule is designed to restrain banks from engaging in risky activities that could threaten clients’ federally insured deposits.
***JB:  Has any market regulation ever gone into effect on the date it was supposed to?

***DA: Do tax increases count?

CME Group fines three firms for automated trading violations
Mike Fox – LeapRate
In a Reuters news bulletin that slipped under the radar over the weekend, CME Group (NASDAQ:CME) reported last Friday that it fined three Chicago-based proprietary trading firms for violations stemming from problems with automated trading systems.
The firms, 303 Proprietary Trading, Allston Trading and Traditum Group, had no immediate comment or declined to comment.

CHICAGO: Fish & Richardson Wins Attorneys’ Fees for Chicago Board Options Exchange in Multi-Year Patent Dispute With ISE
Business Wire | Rock Hill Herald Online
Fish & Richardson announced today that the Chicago Board Options Exchange, Incorporated (CBOE) has been awarded attorneys’ fees in its eight-year patent dispute with International Securities Exchange (ISE). On December 10, 2014, Judge Joan H. Lefkow in the U.S. District Court Northern District of Illinois, Eastern Division granted CBOE’s motion for attorneys’ fees under the exceptional case doctrine.


A Strategy That Paid Dividends
Steven M. Sears – Barron’s
In a year marked by low volatility, one must deal wisely with boredom. This column favored an approach I dubbed the conditional dividend strategy.
It involved selling puts on high-quality stocks with payouts. If the shares rose, as most did in 2014, the put sales simply generated added income. If the shares fell below the strike price at expiration, the put seller was obligated to buy the stock. There is nothing fancy about this options strategy, but it proved effective.

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