TOM has been gamed
The option exchange TOM has been gamed by a trader. The case came the light last week, after a string of suspicious trades in AEX index options. The exchange hasn’t lost any money on the (alleged) manipulation. The burden was for the market makers. This case of alleged cross-venue manipulation is a bit of a complicated story for outsiders, I’m afraid.
Basic background
On the multilateral trading facility TOM (“The Order Machine“), options are listed on Dutch stocks and the AEX index. The same options are also trading on Euronext. In other words, there are usually two markets for the same option at the same time. A third option exchange, Eurex, doesn’t play a role in this story.
Stat trades
Banks like ABN AMRO and brokers like Binck are connected to TOM. There is a kind of monopoly, as all orders from these connected brokers are routed to TOM. There can be a better market on the Euronext market in an option. TOM guarantees best execution. It compares the price on their own trading platform with Euronext. TOM explains it like this.
If the client sends a market buy order in an option, and the price on Euronext is lower – it get’s executed on TOM against Euronext’s price. What happens is this:
- TOM Broker buys the lower offer on Euronext
- TOM Broker gives this Euronext trade to a market maker
- TOM Broker executes the client buy order against the market maker on TOM MTF (Multilateral Trading Facility)
- Market maker ends up with a long position on Euronext, and short position on TOM MTF in the same instrument. Matched against the same price. Market maker gets a small rebate for this service.
We call this a “stat trade“.
Opt out
The next step was to allow market makers to opt out of the automatic hedge on Euronext. Market makers can say, “if there’s a better price for the retail customer on Euronext, we are willing to trade against the customer. No matter the price on Euronext“.
This makes sense. TOM can execute everything on their own platform. Market makers get the trades, and have the possibility to decide between scratching the trade on Euronext or to keep the trade.
As a result, less volume will move to Euronext. The market maker on Euronext with tight quotes will do less trade volume on his quotes. In practice, this isn’t much of a problem for market makers. Apart from All Options, every market maker is active on both exchanges. Euronext isn’t happy.
The manipulation
Jerry gives a sharp offer in an option on Euronext. Then Jerry logs in into his Binck or ABN retail account, and gives a buy order with the same price as his own offer on Euronext. His buy order will be executed on TOM against a randomly assigned market maker. Jerry’s offer on Euronext remains untouched. Jerry quickly withdraws his offer on Euronext.
This is what happened in the AEX options on TOM. Longer dated AEX options have wider spreads. More possibility to game the opt out system. Market surveillance at TOM noted the strange trades last week. They switched off the Opt Out functionality completely.
Where is the money?
How does Jerry make money with this? He could to the same trick the other way around. Scalping a few cents profit. Alternatively, he could game the market makers and the exchange for more advanced strategies. Building a more complex option position against profitable prices.
It’s not easy to make a substantial profit with this manipulation. The fake order on Euronext can’t be too sharp – your order may be executed at a bad price. Only options with a large bid/ask spread can be used. Regular stock options have very tight option quotes, which make them almost impossible to manipulate.
Smoking gun
TOM can only suspect manipulation and report it to the regulator. For evidence, you need the full cooperation of two exchanges and at least two brokers. One of the brokers may be located in another country. Time-consuming.
But there is a smoking gun. According to an official statement from TOM, the manipulation was done while concealing the ownership of the transactions involved. The Dutch watchdog AFM is involved in the matter. Expect follow-up news from the AFM after they identified the manipulator.
Statement from TOM
This isn’t just speculation and gossip. Thursday July 7th there was an official statement from TOM – confirming the issue.
Recently we detected cross market manipulative behavior which could only take place by making use of the specifics of the TOM STAT Opt out functionality and trading access to and knowledge of the Dutch derivatives markets where options with the same contract specifications are traded (i.e. Euronext and TOM MTF). The recent case involved entering orders without a bonafide intention to trade and with the purpose of improperly influencing pricing across markets. This was done in a structured manner, potentially by one or more persons acting in concert, whilst concealing the ownership of the transactions concerned.
Small time crooks
The whole thing with concealing the ownership gives it a weird touch. After all, we’re not talking about millions here. Market makers losing money on strange trades, they will be fast to discover what’s going on. Yes, ripping a few market makers for a few thousand euro a day is possible. But it won’t last long. Concealing identity is a difficult thing to do, especially when there’s money involved.
I know the small time crooks involved will be reading this. The AFM is after you, and I guess you have a few weeks left. Take the plane to South America while you still can. Buy a new identity. Alternatively, you could stay and gamble on the Dutch court failing to understand “opt out” trades.
Disclaimer : the description of stat trades, and especially “best execution” is kept simple on purpose.
THAN DON’T FACILITATE IT: opt-out !!!
Recently we detected cross market manipulative behavior which could only take place by making use of the specifics of the TOM STAT Opt out functionality …
the specifics are, that because of lousy hardware in Slough and outdated NASDAQ OMX-software these kind of games are possible
In Italy if a ratail try to alter the prices of two different markets ( bond ) is having to pay fines 100k plus the seizure of the gain
I don’t get it. Why blame poor Jerry?
If a market maker is stupid enough to base his trading decisions on the fact that, allegedly, another market participant is willing to do the same trade, then he must also accept the potential consequences.
Let’s imagine another case when our stupid but greedy market maker gets a good trade by, basically, stealing it from someone on Euronext (this can be a retailer as well, btw). Is this fair? I say it is a damn hft-front-running bullshit.
So, screw the stupid market maker. Well done Jerry.
Which Jerry are we talking about ?
Sure it is not a Chris ?
They should make a cartoon about it.
Tom & Jerry
@Aleksey
The market makers on Euronext are the very same market makers as on TOM MTF.
Nobody is stealing anything.
I guess it sucks to be a designated market maker on TOM today. Time to let the big boy(s) like Virtu take care of all the business.
Maybe the intentions of this activity were manipulative, maybe though Jerry just wanted to close down some Tom/Euronext spread positions from his book. Executing this way doesn’t automatically imply manipulation unless Jerry would try to scalp his transactions later on on the same platform. Opting out in general should free money for the MM: having quote exposure without the risk of being picked off. That this sometimes backfires is just a fair part of the game.
This is the most obvious kind of market manipulation. Finally an easy case for the AFM.
When an HFT pulls his order on another exchange after getting a fill elsewhere, it’s called “providing liquidity”. When someone else does it, it’s called gaming. Difficult to find sympathy for someone dumb enough to say “sure I’ll match whatever best price may be found somewhere else”.
And of course Euronext will have a field day saying that they warned investors and the regulator alike that the integrity of the market would be jeopardized if TOM were to be granted a license to operate and deal in the same options as on Euronext.
@7.29
You can’t compare this with HFT strategy. This case the guy basically tried to lift his OWN offer.
He gave an offer on one exchange, and a bid on other exchange – on the same price. HFT has bids on the same side.
@ 8:07
HFTs regularly trade against themselves (too) and blame volatile markets, a sudden change in prices and what have you not. “Everyone does it.” HFTs will often decide to reverse a buy by sending a sell order with price Y on exchange A which will be executed before their cancellation message for their bid order with price Y on exchange B has been processed by that exchange. It is absolutely the same thing!
This guy did not try to trade against his own order. He placed an order on Euronext, then he sent an order to the other exchange, TOM. Besides, he ends up getting only one execution and actual exposure. How is that trading against yourself?
When you think about it, a market maker with Opt In essentially trades against himself! He buys on TOM at price X and simultaneously sells on Euronext against the same price (TOM first do the leg on Euronext, then immediately match the market maker against the client order and pass along TWO trade executions to the market maker).
Please explain to me why it is OK for a market maker to do a trade that has in principle no economic benefit (buying and selling at the same price at exactly the same time) but this guy is accused of manipulating markets because he supposedly tried to trade against himself?
This entire mess only exists because of the way TOM was conceived. From a legal POV a TOM option is not the same as the one on Euronext and never will be. In order to appease the regulator and Euronext who took them to court, TOM is forced to do an opposing trade on their own platform every time best execution would take place on Euronext, thereby creating the illusion of liquidity (turnover is doubled). The regulator should not condone this setup and revoke the TOM license immediately, rather than going after the guy who figured out how he can get price improvement thanks to stupid market makers.
Bunch of sore losers these market makers/HFTs.
@13:42 The rules of the trading game change all the time, and when the old useless farts can’t be bothered to go with the flow and improve their practices they instead make a big stink. HTFs rule!
@9:14 As a market maker (or as a matter of fact as any type of exchange member) you shouldn’t trade against yourself, such trades are against (at least) exchange regulations. If you don’t respect these rules you end up loosing your license. You better be able to explain if you do this on a regular basis.
Some market models allow a member to trade against himself but only if he announces before his intention and waits some time for other market participants to “jump in” and be willing to take the other side.
Some exchange even offer self-trade protection mechanisms (where if you by mistake are about to trade with yourself then, depending on the mechanism and it’s parameters, the outcome might be, for example, that the orderbook changes by reducing the quantity on one side).
It generally doesn’t make send to intentionally trade against yourself, it’s cheaper (no transaction costs), faster (not involving the matching engine) to either change or delete your order/quote.
This post is from last Friday, no one is in then at the AFM.
Same for Monday and Wednesday. But markets don’t get manipulated on these day’s, so that’s perfectly okay.
With al little luck they will take action tomorrow.
Action against TOM and DeGiro that is, with their ‘Opt-OUT’ and ‘JOIN-order’.
NO displaying of prices, NO exposure.
The regulator should not condone this setup and revoke the TOM license immediately, rather than going after the guy who figured out how he can get price improvement thanks to stupid market makers.
Most likely the AFM has no clue at all where the agreed with.
DeGiro’s “join-order” aspecially.
Why do market makers choose “Opt Out”? What is the benefit?
If market makers do not “opt out”, they will not have any risk, won’t they?
Art. 12 Market Abuse Regulation (entered into force last week):
1. For the purposes of this Regulation, market manipulation shall comprise the following activities:
(a) entering into a transaction, placing an order to trade or any other behaviour which:
(i) gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument, [];
(ii) secures, or is likely to secure, the price of one or several financial instruments, [] at an abnormal or artificial level;
Entering an order on Euronext without the intention of trading on that price (except on the other side on another venue) seems like textbook “misleading signal as to the supply of …”.
People place orders and do trades that seem illogical at first glance every day. For example, people who are trying to close an ADR vs ORD position at a slight loss, i.e. buying and selling two different but closely related securities at overlapping prices.
No abuse on Euronext:
There is no such thing as an illusion of liquidity or a false price when placing orders INSIDE the spread on Euronext precisely BECAUSE market makers on TOM have obligated themselves to MATCH any such a price improving order. Every market maker on TOM is therefore complicit in any price improving order if such an order were to be considered misleading or false! Think about it: if the guy’s sell order @ 8.75 was misleading, shouldn’t the dumbass market maker who sold on TOM @ 8.75 be prosecuted for the same market abuse?
No abuse on TOM:
The guy’s price on TOM cannot be considered false or misleading because the trade was not busted by the exchange. Besides, he placed his order WITHJN the quote of all market makers. That’s not manipulation, that’s price improvement! And his quantity (less than 10 contracts!) certainly cannot be considered deceptive under any circumstances.