Sat 15 May 2010
Here’s some more insightful analysis from “a young analyst” via Ritholtz:
It boils down to this: this episode exposed structural flaws in how a trade is implemented (think orphaned algo orders) and it exposed the danger of leaving market making up to a network of entities with no mandate to ensure the smooth and orderly functioning of the market (think of the electronic market makers and high freqs who can pull bids instantaneously as opposed to a specialist on the floor who has a clearly defined mandate to provide liquidity).
This is not the market of olde times… with effectively no market makers, an assumptions about liquidity and always having a bid to hit is now a dangerous assumption.
With this in mind, what are your options in the event of another no-bid situation?
- Buy and Hope (a.k.a. Buy and Hold) — don’t worry about needing to sell, believe in the underlying value of what you own or how the market is currently pricing that value.
- Stand aside whenever the volatility cranks up.
- Panic early and sell before everyone else sells, thus selling before the bids disappear. Note that this will create churn if you want to plunge back in quickly…
- Hedge your positions.
- Enter into married puts to protect your downside. This can be more effective than a stop order in an illiquid market, but carries its own associated costs.
- Put on some short positions to balance your long positions.
- Be prepared with a list of alternative ways to balance your long exposure. If INTC goes no-bid, can you short QQQQ instead? If you’re long PG, can you do a bullish option spread instead? Can you hedge an equity position with a forex trade?
- Are you prepared to buy when no one else does? Some low-ball bids for PG and similar stocks got filled, and the trades didn’t get busted… do you have the guts to buy during panic?
All this advice will work for those of us at the retail level… but there are serious issues for managers of mutual funds. In a market that is stacked against the smaller trader, this ability to be nimble is one of the few advantages to be had.