5 ms·

"When irrational actors are at work (and let’s be clear, anyone selling RSP for half off isn’t being rational), the smartest thing to do, if you’re the actual h

"When irrational actors are at work (and let’s be clear, anyone selling RSP for half off isn’t being rational), the smartest thing to do, if you’re the actual human being watching RSP trade, is to simply step out for a cup of coffee". If you honestly believe that selling for 50% off is irrational, then you should not step out for coffee but put in bids and buy that ETF. That's the rational thing to do, conditional on your beliefs about valuation.

maguirre 11y ago
I would guess that this specific advice would be for those who already own the securities currently being sold at 50% "discount".
- vasilipupkin 11y ago
  I thought the discussion was about market makers, not long term investors? but yes, if you already own your full allocation, then the advice is sound.
- dnadig 11y ago
  Well, plenty of traders are out there selling without actually owning -- that's something market makers and only market makers are allowed to do, and it's certainly possible that market makers algos were selling too low along with high frequency traders. But regardless, when you have a derivatively priced security like RSP (which holds actual stocks -- it has some inherent worth at all times that's knowable) any selling at a discount is supposed to be arbitraged away. In these cases, it wasn't,because the trading windows were too short. (Hi, I'm the author of that blog post).
  - vasilipupkin 11y ago
    right. So if you think selling is irrational and you don't already own it, you should buy, not walk away. If you are not buying, it means you don't believe that the discount is irrational.
  - wusatiuk 11y ago
    a "too short trading window" means that no retail investor had the chance to buy within this 1 hour timeframe, because of the massive amount of order?
  - ddeck 11y ago
    Well, plenty of traders are out there selling without actually owning -- that's something market makers and only market makers are allowed to do I assume you are referring to naked short selling. To be clear, anyone may borrow shares and then sell them. Although legal ownership does pass to the borrower, this is not what most people think of if told they must "own shares prior to selling them". In fact under SEC regulations, the borrow doesn't actually need to take place before the sale, so long as the broker has reasonable grounds to believe that the security can be borrowed to satisfy delivery for the sale. From the retail traders perspective, this is typically transparent. They simply enter a sell order in a security that they don't own, and their broker worries about locating it for delivery (or doesn't allow the trade if it believes it can't locate the shares).
    - minimax 11y ago
      The morning of 8/24 was more complicated than that because lots of these stocks/etfs had hit their Reg SHO thresholds, which restricted the ability short sell into a resting bid. https://www.sec.gov/divisions/marketreg/rule201faq.htm https://www.sec.gov/divisions/marketreg/rule201faq.htm
      - mrchicity 11y ago
        And when market-makers lose an option for managing their risk (hitting bids in a related security), they'll naturally charge a wider spread to buy, further diminishing liquidity that would stabilize the market.
      - dnadig 11y ago
        SHO limits don't apply to bona fide market making, I'm nearly certain. But regardless, you would expect the inability to short by non-MMs would actually keep ETFs and Stocks from hitting their breakers, not making it worse. By definition, you remove sell-pressure. Until 10AM that day, the problem was zero buy-pressure. No bids at all to speak of. http://www.etf.com/sites/default/files/images/2_rspsurveyor.jpg http://www.etf.com/sites/default/files/images/2_rspsurveyor....
  - mrchicity 11y ago
    If the constituent stocks are halted, the inherent value is unknowable. Additionally, there are limits to arbitrage such as capital/loss limits and counterparty risk. Also most high-frequency traders are market-makers or unofficially acting in that role. ISO orders are used by all executing brokers trying to sweep the best price, it's equally likely that the low sells were by funds executing stop loss orders through a brokerage or bank or wholesale market makers offsetting inventory at a loss after providing liquidity to retail stops.
mrchicity 11y ago
Thing is, most ETF liquidity is provided by high-speed market making algorithms. ETF pricing works through an arbitrage mechanism. To give a contrived example, imagine a ETF "Mega-Tech" (MGT) whose composition is 0.75 shares AAPL and 0.25 shares GOOG. At the close of trading, large arbitrageurs can exchange MGT shares in-kind with the ETF issuer for 0.75 shares AAPL and 0.25 shares GOOG or vice-versa. If the ETF is ever trading for more or less than 0.75AAPL + 0.25GOOG, you can make money going long the stocks and short the ETF or vice-versa. So, knowing where AAPL and GOOG are trading, the ETF market-maker sets his bid and offer in MGT such that he can try to trade AAPL and GOOG at a better price to offset his risk and capture a small profit. Since this position is fully hedged, he gets special capital treatment and can accumulate large inventory in the ETF if there's a large imbalance between natural buyers and sellers. Now, imagine AAPL is halted. The ETF market-maker can't hedge his risk or have confidence in what the ETF is worth. At first, he updates his pricing to assume the worst (remember, this is a dumb risk-averse computer, maybe AAPL is halted because it's the next Enron) and bids a lower price. He can't get the same capital treatment on MGT hedged with GOOG or some other ETF, and this is a much risker trade, more of a statistical arbitrage than a pure one, so as people keep selling MGT to him, he hits a risk or capital limit and pulls his bids completely. Real ETFs can have 100s of components. Since this is a mechanical process, high-speed market-makers can charge a very low spread and be the best bid or offer in the market almost all the time. They just trade 100s of ETFs at once to make it up in volume. This drives humans out of the market-making business, since human traders who did the same thing are undercut by machines. Because of this, few well-capitalized human traders are sitting around waiting to pounce on ETFs trading at a massive discount since it rarely happens. They're all doing something else with their lives. A good solution would be not to allow market orders in ETFs when their component stocks are halted, or to halt trading in ETFs when the components are halted. Market stop orders should probably be banned in general. I can't think of any other business dealing where a person would walk into a store and say "I'll buy/sell this at any price", aside from buying lobster on a date.
idlewords 11y ago
No, stepping out for coffee is the rational thing. Seeing irrational behavior around you means your model of the world is either broken or not applicable to the situation, something worth chewing on for a while. "When you don't know who the sucker in the room is, the sucker is you".
- vasilipupkin 11y ago
  how do you define irrational behavior ? what makes a 50% decline irrational ?
  - droffel 11y ago
    An analogy: In a fictional world, an envelope costs $1, a piece of paper costs $0.50, and a stamp costs $0.50. In total, a full letter costs $2. You know that anyone on the street would be willing to buy each of those items at the component price. Would you not agree that seeing all 3 sold as a bundle for $1 would be irrational?
    - vasilipupkin 11y ago
      no. If someone has a model that tells them everything is about to get cheaper in the next 2 hours and will and cost 50 cents, then rushing in to sell the bundle for $1 is not irrational.
  - dnadig 11y ago
    Since ETFs are derivatively priced, it's irrational on the face of it. If I sell you a bundle of 100 $1 bills for $50, it's irrational. ETFs are wrappers around stacks of stocks.
    - vasilipupkin 11y ago
      not unless the ETF leads the basket of stocks down. For example, futures often lead cash, why can't ETFs lead their constituents ? if stocks are about to go down 50%, there is nothing automatically irrational about ETFs on those stocks going down 50% first. But, as I said elsewhere, if you think it is irrational, then buy the ETF
eogjnjoeg 11y ago
No, that's irrational. Stock opens at X, you buy at 0.5X, you sell at 0.9X, it goes back to X. Then the exchange breaks the 0.5x trade. Now you still have to deliver the order you sold at 0.9x, but you're buying it at X, so you've earned a neat loss. The rational thing to do is to get a cup of coffee. Unless you enjoy losing tons of money, in which case your idea is great as well.
- vasilipupkin 11y ago
  you are confusing various scenarios with the expectation. If you believe that a 50% decline is not justified rationally, meaning by expected future cashflows of this asset, then the asset is by definition underpriced and you should buy it. Or, stop claiming that the decline is irrational. Or, define better what you mean by irrational
  - eogjnjoeg 11y ago
    You missed the key point of my post which is that your purchase at 0.5x will almost certainly be broken by the exchange, so the odds aren't what you naively pretending they are. This ignorance on your part means that you misunderstand what would be rational. And the arrogance on your part means that you felt it appropriate to be a dick to somebody who understands the problem space better than you do. You are an ignorant and arrogant fool who is dunning-kreugering himself. Don't bother responding; I already know that you're an arrogant asshole who is not interested in a conversation, isn't capable of admitting error, and who won't ever be worthy of any form of respect. You're whale shit.
    - monochromatic 11y ago
      > Be civil. Don't say things you wouldn't say in a face-to-face conversation. Avoid gratuitous negativity. > When disagreeing, please reply to the argument instead of calling names. E.g. "That is idiotic; 1 + 1 is 2, not 3" can be shortened to "1 + 1 is 2, not 3." https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html
    - 11y ago

maguirre 11y ago

I would guess that this specific advice would be for those who already own the securities currently being sold at 50% "discount".

vasilipupkin 11y ago
I thought the discussion was about market makers, not long term investors? but yes, if you already own your full allocation, then the advice is sound.
dnadig 11y ago
Well, plenty of traders are out there selling without actually owning -- that's something market makers and only market makers are allowed to do, and it's certainly possible that market makers algos were selling too low along with high frequency traders. But regardless, when you have a derivatively priced security like RSP (which holds actual stocks -- it has some inherent worth at all times that's knowable) any selling at a discount is supposed to be arbitraged away. In these cases, it wasn't,because the trading windows were too short. (Hi, I'm the author of that blog post).
- vasilipupkin 11y ago
  right. So if you think selling is irrational and you don't already own it, you should buy, not walk away. If you are not buying, it means you don't believe that the discount is irrational.
- wusatiuk 11y ago
  a "too short trading window" means that no retail investor had the chance to buy within this 1 hour timeframe, because of the massive amount of order?
- ddeck 11y ago
  Well, plenty of traders are out there selling without actually owning -- that's something market makers and only market makers are allowed to do I assume you are referring to naked short selling. To be clear, anyone may borrow shares and then sell them. Although legal ownership does pass to the borrower, this is not what most people think of if told they must "own shares prior to selling them". In fact under SEC regulations, the borrow doesn't actually need to take place before the sale, so long as the broker has reasonable grounds to believe that the security can be borrowed to satisfy delivery for the sale. From the retail traders perspective, this is typically transparent. They simply enter a sell order in a security that they don't own, and their broker worries about locating it for delivery (or doesn't allow the trade if it believes it can't locate the shares).
  - minimax 11y ago
    The morning of 8/24 was more complicated than that because lots of these stocks/etfs had hit their Reg SHO thresholds, which restricted the ability short sell into a resting bid. https://www.sec.gov/divisions/marketreg/rule201faq.htm https://www.sec.gov/divisions/marketreg/rule201faq.htm
    - mrchicity 11y ago
      And when market-makers lose an option for managing their risk (hitting bids in a related security), they'll naturally charge a wider spread to buy, further diminishing liquidity that would stabilize the market.
    - dnadig 11y ago
      SHO limits don't apply to bona fide market making, I'm nearly certain. But regardless, you would expect the inability to short by non-MMs would actually keep ETFs and Stocks from hitting their breakers, not making it worse. By definition, you remove sell-pressure. Until 10AM that day, the problem was zero buy-pressure. No bids at all to speak of. http://www.etf.com/sites/default/files/images/2_rspsurveyor.jpg http://www.etf.com/sites/default/files/images/2_rspsurveyor....
- mrchicity 11y ago
  If the constituent stocks are halted, the inherent value is unknowable. Additionally, there are limits to arbitrage such as capital/loss limits and counterparty risk. Also most high-frequency traders are market-makers or unofficially acting in that role. ISO orders are used by all executing brokers trying to sweep the best price, it's equally likely that the low sells were by funds executing stop loss orders through a brokerage or bank or wholesale market makers offsetting inventory at a loss after providing liquidity to retail stops.

mrchicity 11y ago

Thing is, most ETF liquidity is provided by high-speed market making algorithms. ETF pricing works through an arbitrage mechanism. To give a contrived example, imagine a ETF "Mega-Tech" (MGT) whose composition is 0.75 shares AAPL and 0.25 shares GOOG. At the close of trading, large arbitrageurs can exchange MGT shares in-kind with the ETF issuer for 0.75 shares AAPL and 0.25 shares GOOG or vice-versa. If the ETF is ever trading for more or less than 0.75AAPL + 0.25GOOG, you can make money going long the stocks and short the ETF or vice-versa. So, knowing where AAPL and GOOG are trading, the ETF market-maker sets his bid and offer in MGT such that he can try to trade AAPL and GOOG at a better price to offset his risk and capture a small profit. Since this position is fully hedged, he gets special capital treatment and can accumulate large inventory in the ETF if there's a large imbalance between natural buyers and sellers. Now, imagine AAPL is halted. The ETF market-maker can't hedge his risk or have confidence in what the ETF is worth. At first, he updates his pricing to assume the worst (remember, this is a dumb risk-averse computer, maybe AAPL is halted because it's the next Enron) and bids a lower price. He can't get the same capital treatment on MGT hedged with GOOG or some other ETF, and this is a much risker trade, more of a statistical arbitrage than a pure one, so as people keep selling MGT to him, he hits a risk or capital limit and pulls his bids completely. Real ETFs can have 100s of components. Since this is a mechanical process, high-speed market-makers can charge a very low spread and be the best bid or offer in the market almost all the time. They just trade 100s of ETFs at once to make it up in volume. This drives humans out of the market-making business, since human traders who did the same thing are undercut by machines. Because of this, few well-capitalized human traders are sitting around waiting to pounce on ETFs trading at a massive discount since it rarely happens. They're all doing something else with their lives. A good solution would be not to allow market orders in ETFs when their component stocks are halted, or to halt trading in ETFs when the components are halted. Market stop orders should probably be banned in general. I can't think of any other business dealing where a person would walk into a store and say "I'll buy/sell this at any price", aside from buying lobster on a date.

idlewords 11y ago

No, stepping out for coffee is the rational thing. Seeing irrational behavior around you means your model of the world is either broken or not applicable to the situation, something worth chewing on for a while. "When you don't know who the sucker in the room is, the sucker is you".

vasilipupkin 11y ago
how do you define irrational behavior ? what makes a 50% decline irrational ?
- droffel 11y ago
  An analogy: In a fictional world, an envelope costs $1, a piece of paper costs $0.50, and a stamp costs $0.50. In total, a full letter costs $2. You know that anyone on the street would be willing to buy each of those items at the component price. Would you not agree that seeing all 3 sold as a bundle for $1 would be irrational?
  - vasilipupkin 11y ago
    no. If someone has a model that tells them everything is about to get cheaper in the next 2 hours and will and cost 50 cents, then rushing in to sell the bundle for $1 is not irrational.
- dnadig 11y ago
  Since ETFs are derivatively priced, it's irrational on the face of it. If I sell you a bundle of 100 $1 bills for $50, it's irrational. ETFs are wrappers around stacks of stocks.
  - vasilipupkin 11y ago
    not unless the ETF leads the basket of stocks down. For example, futures often lead cash, why can't ETFs lead their constituents ? if stocks are about to go down 50%, there is nothing automatically irrational about ETFs on those stocks going down 50% first. But, as I said elsewhere, if you think it is irrational, then buy the ETF

eogjnjoeg 11y ago

No, that's irrational. Stock opens at X, you buy at 0.5X, you sell at 0.9X, it goes back to X. Then the exchange breaks the 0.5x trade. Now you still have to deliver the order you sold at 0.9x, but you're buying it at X, so you've earned a neat loss. The rational thing to do is to get a cup of coffee. Unless you enjoy losing tons of money, in which case your idea is great as well.

vasilipupkin 11y ago
you are confusing various scenarios with the expectation. If you believe that a 50% decline is not justified rationally, meaning by expected future cashflows of this asset, then the asset is by definition underpriced and you should buy it. Or, stop claiming that the decline is irrational. Or, define better what you mean by irrational
- eogjnjoeg 11y ago
  You missed the key point of my post which is that your purchase at 0.5x will almost certainly be broken by the exchange, so the odds aren't what you naively pretending they are. This ignorance on your part means that you misunderstand what would be rational. And the arrogance on your part means that you felt it appropriate to be a dick to somebody who understands the problem space better than you do. You are an ignorant and arrogant fool who is dunning-kreugering himself. Don't bother responding; I already know that you're an arrogant asshole who is not interested in a conversation, isn't capable of admitting error, and who won't ever be worthy of any form of respect. You're whale shit.
  - monochromatic 11y ago
    > Be civil. Don't say things you wouldn't say in a face-to-face conversation. Avoid gratuitous negativity. > When disagreeing, please reply to the argument instead of calling names. E.g. "That is idiotic; 1 + 1 is 2, not 3" can be shortened to "1 + 1 is 2, not 3." https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html
  - 11y ago