‘Flash crash’ started by single trade of index futures

The catalyst for the “flash crash” on 6 May was a single trade by an institutional investor who sold $4.1bn of index futures, according to a new report released by US regulators.

The report, issued by the Securities and Exchange Commission in conjunction with the Commodities Futures Trading Commission, says the trade was initiated by "a large fundamental trader," who used an automated program to sell 75,000 E-Mini S&P 500 futures as a hedge to an existing equity position.

The report says the sell program was executed by the investor "extremely rapidly," taking only 20 minutes.

The rapid trade propagated further sales by other automated programs. This was combined with selling pressure from high frequency traders, which saw the price of the E-Mini driven down by approximately 3% in four minutes, from 2.41pm.

During this price decline, buyers were purchasing the E-Mini while selling the more expensive SPDR S&P 500 ETF or baskets of individual securities. Yet the report says this buying and selling activity was not enough - in terms of speed or quantity - to keep up with the selling pressure in the E-Mini futures.

The high frequency algorithmic trading, which led to the withdrawal of liquidity, saw the Dow Jones Industrial Average index plummet almost 1,000 points during that day, before sharply rebounding.

The report interviewed 15 large trading firms that were involved in buying the E-Mini, who say price changes in these futures generally lead price changes in the SPDR S&P 500 ETF and in the basket of underlying stocks.

They also say E-Mini prices led the decline on 6 May and were relatively cheaper than either the SPDR ETF or baskets of individual securities.

The report concludes that, in stressed market conditions, the automated execution of a large sell order can spark extreme price movements, especially if the automated program does not account for prices.

It says the "interaction" between automated execution programs and algorithmic trading strategies can "quickly erode liquidity and result in disorderly" markets.

The regulators also say 6 May highlighted the inter-connectedness of the derivatives and securities markets, especially in relation to index products.

Consequently, the SEC and CFTC are working with the markets to consider recalibrating existing circuit breakers to apply across all equity trading venues and the futures markets.

The report says none of these existing market-wide circuit breakers were triggered on 6 May.