Nearly five years after the so-called “flash crash”—when the market dropped hundreds of points in the span of a few minutes on May 6, 2010—authorities have arrested a trader that they believe helped cause the swoon.
But the alleged culprit, a U.K.-based futures trader named Navinder Singh Sarao, didn’t actually make a whole lot of money off the flash crash, according to the U.S. Justice Department’s criminal complaint against Sarao.
The complaint, which accuses Sarao of manipulating market prices by fraudulently trading S&P 500 futures contracts, says that he netted $879,018 in profits on the day of the crash.
But that was a relatively small haul compared to Sarao’s gains on other days where he used the same strategy, according to the indictment. For example, more than a year later, on August 4, 2011, Sarao allegedly reaped more than $4 million by manipulating the prices of the same kinds of contracts.
Sarao’s strategy, described in the 35-page complaint by FBI special agent Gregory Laberta, involved placing large orders for electronic S&P 500 futures contracts known as “E-minis,” only to cancel them before the orders were actually executed. The practice is known as “spoofing” and it is illegal.
Using automated trading software, Sarao allegedly placed repeat bogus orders to sell huge blocks of E-minis, artificially pushing the market price of the futures contracts down. Once the price dropped, he would then execute real trades to buy the contracts at the lower price, while simultaneously cancelling his original sell orders. Next, he would turn around and use spoofing to drive the price of the contracts back up, actually selling some at the higher price while cancelling the rest of his fake orders.
Between 2010 and 2014, Sarao made a total of roughly $40 million using that strategy—and he was still actively spoofing through at least the first week of April, according to a separate civil complaint against Sarao by the U.S. Commodity Futures Trading Commission.
But if Sarao’s actions really did lead to the flash crash, it’s unclear why they only caused a single one—especially when that wasn’t even his biggest windfall amid a long-running scheme.
Indeed, Sarao’s conduct on the day of the flash crash actually seems pretty ordinary for him, by the FBI agent’s account. Over a period of two hours starting in the early afternoon New York time, when the Dow was down by more than 300 points, Sarao allegedly traded more than 62,000 E-mini contracts worth $3.5 billion. But for him that was nothing: The previous day he’d traded E-minis worth more than double that amount (or $7.6 billion); the day after the flash crash, he traded some $8.7 billion of them. (According to an email Sarao sent in 2012, cited in the complaint, the trader bragged that he “made the majority of [his] net worth” in “no more than 20 days trading.”)
Still, the day of the flash crash, Sarao’s spoof orders somehow created an “extreme order book imbalance” on the Chicago Mercantile Exchange (CME), the primary place where E-minis are traded. During the two-hour period just before the flash crash, as much as 29% (or nearly a third) of the sell orders on the exchange were coming from Sarao, according to the criminal complaint. At that time, there was “little liquidity left in the market,” as there were more than twice as many sell orders as buy orders for E-mini futures contracts, the complaint says.
And that’s when the market went into free fall—triggering the “flash crash” at about 2:45 p.m. As investors (or their algorithmic trading programs) noticed what appeared to be a major fire sale of E-minis, the sell-off “spilled into equities markets” as traders dumped stock: The Dow shed another 600 points in a matter of five minutes, and was briefly down by 1000 points.
And if E-minis trading had caused the crash, all it took was a quick timeout to stop the chaos: the CME halted trading in E-minis for five seconds, and the market mostly recovered by 3 p.m.
The very next day, it was rinse-and-repeat for Sarao, who kept up his spoofing routine as though nothing ever happened, according to the complaint. So why hasn’t there been another flash crash since (other than the brief 2013 swoon following a hoax tweet about a White House attack)?
One theory is that it wasn’t just Sarao, but a confluence of spoof traders or price manipulators who caused the market imbalance; Sarao is simply the only one—or perhaps just the first—to get caught. It just may take another flash crash for government regulators to find the others.
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