Program Trading and the Link Between the Spot and Futures Prices

Abstract

Program trading has been identified as a mechanism that links the futures and spot markets. It has also been identified as a potential cause of market instability leading to regulations on program trading during volatile markets. Program trading halts provide a natural experiment to test the hypothesis that program trading is an important mechanism that maintains relative market pricing. This study is the first to analyze the effect of removing all program trades on the connectedness of the spot and futures markets during large market moves. The Korean regulatory environment has several unique properties that lend itself to such a study. Overall, we provide evidence that (i) the basis is unaffected when program trading is eliminated during large market moves, (ii) arbitrage exists and appears to be able to identify uninformed price moves, (iii) the data do not support the argument that halts provide a time‐out period in order for markets to reevaluate information, and (iv) there are costs associated with imposing trading halt regulations on financial markets. © 2014 Wiley Periodicals, Inc. Jrl Fut Mark 35:1133–1153, 2015

Programs trades and trade regulation: An evidence of the Korean securities market

“…The second important point in this table is that in three of the four cases where trading is not allowed TIM increased over the 5‐min halt period. Although this evidence is not statistically based, these results are consistent with the result of Jordan et al () and all the results conducted in this study.…”

“…The increase in trading activity after the halt in program trading implies that information asymmetry is not fully resolved during the halt period. Our study further investigates the result of Jordan et al (2015) by analyzing the minute-by-minute trade imbalance around the sidecar events. Table 8 shows the minute-by-minute trade imbalance (|TIM|) for KOSPI 200 stocks in the spot market.…”

“…When liquidity is at a premium, eliminating all program trades also eliminates market stabilizing program trades; (b) this paper is one of the first studies on the effect of program trading halts on a driver of large market moves and also is one of a few papers that specifically looks at sidecars. While Jordan, Lee, and Park () study the effect of sidecar on the link of the spot and futures markets prices using the Korean market data, our study essentially focuses on whether sidecar is an effective regulatory mechanism on program trading by conducting an analysis of stock market quality during large market moves; (c) we use Korean market data set for which program trading is simultaneously halted in all markets (spot, futures, and options) and where there is no good substitute for the index futures or options; and (d) we explore policy implications for improving program trade regulation.…”

Recent Advances in the Literature: Asia-Pacific Derivative Markets

“…For example, Jordan et al . () use Korean data to ascertain if the basis (i.e., the difference between spot futures prices) is affected by halts to program trading only across spot, futures, and option markets. They enumerate the advantages that the Korean regulatory system has for testing this question and argue: “The rich features of the Korean data allow us to test this question across different trade types, including: index arbitrage, non‐index arbitrage, and non‐program trades.” They report, inter alia , there is little evidence that program trading halts affect the basis.…”

Circuit Breakers, Trading Collars, and Volatility Transmission Across Markets: Evidence from NYSE Rule 80A

“…There are relatively few papers that examine the effects of sidecar provisions on program trades and the stock and futures markets. One notable exception is Jordan, Lee and Park (), who examine the program trading sidecar provisions on the Korean Stock Exchange and find that the spot market is adversely affected when the sidecar is in effect and that order imbalances are improved when the sidecar is not in effect. However, they find that sidecars do help during large market movements.…”