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Programs

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Yesterday's strong market perplexed many. The morning's economic data if anything was weak: bonds by the end of the day were stronger. After the data was released S&P futures were trading lower and it looked like stocks would be under pressure. But unexpectedly stocks were firm at the opening and gained strength as the session wore on.

It seemed that buyers completely ignored the economic data. But perhaps they had already made the decision (and the commitment) to buy even before the data was released. If this was the case, the primary buyers would probably have to be a small select group, maybe even one participant. The previous day's close may give some clues as to why this may be so.

At 2:30 the previous day the market was at its weakest. All of a sudden it stopped going down and began rising precipitously. Analyzing the tick data at this time reveals a very significant 1500 point swing (from a -1000 to +500) at precisely this time. The selling was almost instantaneously overwhelmed with buying. It seems someone knew something.

I have written in another piece of how in the 80's and 90's there was a great effort by mutual funds and their consultants to reduce commissions they paid wall street brokers. Wall Street, being a little smarter than their customers, devised strategies that took from Peter to pay Paul: they acquiesced to lower commissions at the expense of market impact.

One of the strategies that developed as result of this process that was designed in an attempt to mitigate this new problem of market impact is called a "blind program".

A customer who wants to buy a list of stocks (and/or sell a list) would submit to a select group of brokers a statistical description of the program to "bid" on. The broker does not get the actual names of the stocks. The bid price is in a commission amount.

For example, let's say on Wednesday three different brokers got a call from BS Mutual fund for a request to bid on a blind program for the next day. BS sends each broker a sheet listing things like dollar amount to buy and dollar amount to sell broken out by sector; average, mean, and maximum and minimum market capitalization of each sector; liquidity statistics of each sector; etc.

Let's put it this way: enough statistics are revealed to the broker that even though they do not have the names of the stocks, they can very precisely determine the amount of risk involved in executing the program. Each broker then bids in cents per share what they are willing to charge to do this program. The risk is that they promise the customer the closing prices of the previous day.

Why would a broker promise the previous day's closing prices: this seems on the surface a great deal of risk to take? I will tell you that statistically there is risk, but maybe not as much as you think. Some stocks they will make money on and some they will lose money on, and they are working against themselves as they buy stocks that they owe offer prices on and sell stocks that they owe bid prices on. But they also get a great deal of extraneous information on which they can make a great deal of money, the primary one being dollars to buy and dollars to sell.

So on Wednesday at 2:30 a few brokers received a statistical sheet that among many other things told them that the next day the customer was net buying a great dollar amount of stocks. That information "somehow" got into the market right away.

An analysis of the tick data from yesterday reveals a pattern consistent with program buying. Program buying normally represents buying from a small number of participants, not buying from a large diverse group of investors.

I do not know for sure that this was the case, but the pattern fits the data. Regardless, it was an opportunity to explain one of the obtuse tools used by wall street.
No positions in stocks mentioned.

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