By Hedge Ly
As ZeroHedge so timely pointed out while most of us were out doing other things Friday afternoon after the market closed, the DXY, (ie DXZ0) contract completely fell out of bed. Last week we had an after hours flash crash in the SPY, and as early as Wednesday of this week we had Ambac Financial ABK fall out of bed nearly 91 cents taking the stock to .08c before recovering. The common theme with these crashes is the market comes back within these products and they were all after hours a few minutes post regular session. What happens when something like the SPY or DXY flash crash happens during the first few minutes of trading or at lunch when no one is at their machines? Answer: All hell would break loose. Algorithms designed to protect and hedge massive portfolio's of derivatives will jump into action running their armageddon program.
You think these armageddon programs do not exist? They do. A human cannot lay off billions of dollars of risk in seconds, only dumb machines programed to do what they are told, they do not think. Thus when a flash crash occurs these programs do not know if it is a mistake and the trades will ge cancelled, they will
jump into action. This jump into action will trigger other events specifically correlated to ETFs and index option hedging strategies. These programs and strategies will create a massive cascade of events which will bring our entire market, not just equities to its knees in minutes. Take the Soviet disaster of Chernobyl as an example of how cascading of seemingly controlled events can turn into something horrible.
When a currency or major index falls 5-10% in minutes/seconds whether by mistake or for real arbitrage and correlation desks will have more alarms go off then in the Chernobyl control room PRE core meltdown. The disaster at Chernobyl was a result of a cascade effect, where many safety devices and checks failed. The core of the reactor is still to this day emits deadly levels of radiation. Just as out markets for years will be tainted for years to come after above event.
A flash crash leading to a cascade of safety and check valve failures in our markets they will simply not pop back and recover in ten minutes, the destruction will be permanent. Radiation will not be around forever, but for the life of human kind it will be............
