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What Happened to Kraft Today?

Wednesday, 3 Oct 2012 | 6:04 PM ET

The Kraft erroneous trades: a bad algorithm, or a lack of liquidity?

An odd opening in the newly minted Kraft Foods has market observers talking. KRFT opened at $45.50 and within a minute went as high as $58 and change before coming back down.

The cancelled trades all occurred in a 15-second period between 9:30am ET and 9:31am ET, in other words right after the open.

A short while later, all trades on all exchanges, were cancelled above $47.82 in KRFT under the "clearly erroneous" trade rules.

(Read more: Unclear What Caused Kraft Spike: Nanex Founder)

How can a stock move 25 percent in less than a minute, on light volume? Let's look at the possible reasons:

1) Could it have anything to do with the Kraft restructuring? The old Kraft Foods changed its name to Mondelez International and spun off its North American grocery business into Kraft Foods Group yesterday. Shareholders received one share of KRFT for every three shares of the old Kraft. KRFT began trading yesterday. Was this a factor? Possibly, but the problems would have likely occurred yesterday, not today.

2) a fat-fingered trade, or an algorithm messing up? Possibly. But if there was a rogue algorithm, it seems it would have traded up on a larger amount of stock. The volume was thin: there were roughly 165 trades made in the cancelled trades, representing roughly 29,000 shares—in about 15 seconds. That is not a lot.

Another oddity: the trades don’t go straight up, as they might have with a rogue buy algorithm: they go back and forth. $50 to $52, and back again. Then, there were was a 100-share trade at $50.11. The next trade: $56.28. The next trade: $56.27. Next: $50.07.

Huh? It's all air.

3) no liquidity. This is an favored by Dennis Dick at Bright Trading, and by others. The books are very thin in most stocks these days, including at the open. Institutional traders don’t put in large limit orders any more. Nobody does. The result: air pockets everywhere.

One good thing about this: the erroneous trade rule does appear to have functioned as intended.

This rule was created after the Flash Crash so that all the exchanges would use the same rules to decide when to cancel trades that were wrongly executed. There's two key components:

1) the broker-dealer who first sent the trades has to come forth and declare them erroneous, and

2) the stock must move a certain percentage to be declared erroneous.

How much it must move depends on several factors, including the price, but in the case of Kraft, it had to move 5 percent past the price it had been trading at prior to the erroneous trades.

All trades, on all exchanges, were cancelled above $47.82 in KRFT. Why $47.82? There was a determination that KRFT began to be impacted at 9:30:01am ET when the trade was at $45.54. A 5 percent move from there gets you to $47.82. Why $45.54? There was a determination that the trading in KRFT was impacted by the erroneous trades from that moment on. More I cannot tell you.

Here's a different question: why didn't the single stock circuit breakers kick in? These circuit breakers requires a 5-minute trading halt when a stock moves more than 10 percent in a five-minute interval.

They didn't kick in because they don't come into effect until 9:45am ET, 15 minutes after the market has opened.

New rules that would kick in next year would eliminate the single stock circuit breakers, setting up a "limit up, limit down" plan that would stop stocks from trading outside of predetermined price bands. Eventually, that will cover the open, but it's not clear when.

We might want to accelerate those plans.

—By CNBC’s Bob Pisani

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  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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