This post is a follow up to the recent interview with Allston Trading's Peter Nabicht, in which Mr. Nabicht alluded to putting "on a trade at the CME and we want to hedge it with an ETF." The following is a deconstruction of just such a trade.
Below is the spread constructed from trading a block of FXB shares against 1 CME-listed GBP futures (6B) contract. Not surprisingly, all of the opportunities to trade this (profitably) are securely tethered to the millisecond level. In addition to the technological arms needed to execute this trade, proper facilitation also requires extensive order-book and inventory management [pdfs].
The two securities are not meant to be purely fungible, so it is not a pure arbitrage. They can however be traded against one another and used as pricing mechanisms for each other. Relationships like this were very involved in the "Flash Crash" [pdf] of May 6, 2010. As liquidity dried up in one product, the pricing mechanism lost integrity and caused the pricing of other assets to suffer in conjunction.
As Andrew Haldane notes, "HFT liquidity, evident in sharply lower peacetime bid-ask spreads, may be illusory. In wartime, it disappears."
Pre and Open Market Spread
Below is the spread constructed from trading a block of FXB shares against 1 CME-listed GBP futures (6B) contract. Not surprisingly, all of the opportunities to trade this (profitably) are securely tethered to the millisecond level. In addition to the technological arms needed to execute this trade, proper facilitation also requires extensive order-book and inventory management [pdfs].
The Outrights.
As Andrew Haldane notes, "HFT liquidity, evident in sharply lower peacetime bid-ask spreads, may be illusory. In wartime, it disappears."
Pre and Open Market Spread
Pre-Market
Opening Hour
Entire Open Market
Closing Hour
This is the strength of the relationship Mr. Nabicht described before and the playing ground of low-latency traders. More examples to follow.
Further Reading:
