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Let's face it, the credit crisis has devoured just about everything we touch and see. Things we thought could never be affected are getting affected. From job loss to losing a home, every American is feeling the pinch.

It also has had a big effect on the volume of the Chicago Mercantile Exchange’s electronic mini S&P futures, called the ES. Over many years of watching the S&P I have seen all levels of cause and effect. I know for a fact when the markets were busy and all the big boys like Louis Bacon of Moore Capital, Paul Jones of Tudor, Bruce Kovner from Caxton and George Soros were all pumping orders into the S&P pit that they were are not doing it for fun. In the ’87 crash every one of the guys I just named sold the S&P days or weeks before.

Generally after a steep decline, volume will drop. As the stock market starts to recover the public starts buying again and the institutions and big banks start making prices again. When that happens, program trading picks up and the volumes jump. It works for everyone all the way down to the guy picking up the phone in the S&P pit. When everyone is trading, liquidity jumps and open interest rises.  Our desk knows all about how that worked back then and how it works today.

In the late ’80s and ’90s every desk in the S&P futures was doing orders. It didn't matter if it was a big or a small order, someone was putting them into the pit. Then in the late ’80s the CME came up with its first order routing system. It was the open outcry system of buying and selling with your hands in the pit. Brokers trading with other brokers, brokers trading with locals and locals trading with other locals all helped make up the bid / offer. Sure you could get some bad fills, but you knew there was going to be a bid to hit or an offer to lift.

In 1989-90, program trading volume started to increase in the S&P futures; everyone wanted to do S&P index arbitrage. It was the craze of the day. By 1995  program trading had become a predominant factor in the S&P futures. It could no longer be overlooked by professional traders. In 1996 electronic trading was introduced. Open outcry volumes were already going down, but as Globex took more volume away from the pit trade, program traders started to automate. The initial cost was high, but it also took out the human error factor. As the pit dried up, electronic ES volumes started to jump. We know from running a desk what “busy” looks like in the S&Ps when everyone is trading. Going into the credit crisis in 2007, overall volume was 2 to 3 mil e-minis a day. As the crisis dragged on, volumes jumped to over 4mil to 5mil contracts a day. You could feel and see the liquidity building up. This buildup was not at all like in the past. In October of 2009, the volume in the CME’s e-mini S&P futures jumped to an all-time high of 6.9mil contracts. As big Wall Street firms went out of business, it drove up the volumes but with the record volume came record liquidation. The more firms and trading desks went out of business, the lower the volumes went. It was a volume bubble in the S&P and it has never recovered.

The credit crisis has not only knocked out some of the big players on Wall Street but it has also affected the retail trader. The absence of this volume is a key factor in why the S&P floats up and down. After a volume spurt, the S&P has to rebuild itself and more stops have to be placed. The space that used to be filled with professional traders, hedge funds and banks and retail traders has been taken up by the algorithms and program trading. This is why the S&P goes from buy stops to sell stops all day long.

In the old days it was big order flow that got things going in the S&P pit and today it’s the algos chasing stops. As traders we need to follow the news, but we also have to be on the lookout for where the closest set of stops are ...

Danny Riley is a 34-year veteran of the trading floor. He has helped run one of the largest S&P desks on the floor of the CME Group since 1985.

Our view:
Until the government comes up with an agreement over the fiscal cliff, the S&P is going to be hanging in the wind. As of today there are 7 days left on Congress’ calendar before it adjourns for the rest of the year. As we have said many times, the S&P hates uncertainty and that is exactly where are are at today. We also have pointed out that the S&P tends to be weak Monday through Wednesday and firm up Thursday and Friday. With that in mind, we lean to selling rallies. As always, keep an eye on the 10-handle rule and please use stops.

Today’s data:

  • It’s 7 a.m. and the SPZ is trading 1409, up 1.9 handles; crude is trading 88.42, down 67 cents; and the euro is up 37 pips at 1.3096.
  • In Asia 6 out of 11 markets closed lower (Shanghai Comp +0.78%, Hang Seng +0.15%).
  • In Europe 6 out of 12 markets are trading lower (CAC +0.70%, DAX +0.28%).
  • Today’s headline: “S&P Futures Signal a Higher Open”
  • Economic calendar: Today: Earnings from AutoZone, Toll Brothers, Pandora, Mattress Firm. WEDNESDAY: Weekly mortgage apps, ADP employment report, productivity & costs, factory orders, ISM non-mfg index, oil inventories; Earnings from Men's Wearhouse. THURSDAY: BoE announcement, Challenger job-cut report, ECB announcement, jobless claims, quarterly services survey, Apple/Samsung hearing; Earnings from H&R Block, Lululemon, Smithfield Foods, Cooper Cos. FRIDAY: Employment situation, consumer sentiment, consumer credit
  • Globex volume: 1.65mil ESZ and 13k SPZ trade
  • Fair value: S&P +1, NASDAQ +3.25

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