Risky Business: NYSE Files To End Its Trading Collars

Our apologies for not listing this post yesterday, as many of you know earnings season is a busy and exciting time in the research industry. As some of our readers may have noticed, the weekend edition of the Wall Street Journal ran a small and under-emphasized (we think) article saying that the New York Stock Exchange has filed to end its trading collars. These collars were put into effect after the '87 crash, and are activated by 2% moves in the NYSE Composite Index. Their purpose is to control the impact of computerized trading programs that invest across the index.

In a move that is meant to help NYSE listed stocks compete more with other less restricted exchanges, the New York Stock Exchange might be removing some of its prestige and security. The trading floor is all but dead, and without collars to calm uncertain markets, risk increases. Computers are now operating on both sides of many trades. Furthermore, many erroneous trades are now busted (or forgiven and taken away), but the trades occur nonetheless.

If the trading collars are removed, the only broad market controls left are the circuit breakers. They are triggered by 10%, 20%, and 30% declines in the Dow Jones Industrial Average. A primary concern is that the Dow comprises only 2% of all stocks listed on the NYSE.

An equally disturbing concern is the seemingly forgotten Dow move on February 27th, of this year. February 27th was the day that trading overloaded the computer system used to calculate average, and stocks were actually trading significantly lower than indicated by the Dow (chart below).

click to enlarge

A third concern is that currently a 10% move in the Dow is 1,387 points. If an investor owned 100 shares of each Dow stock, a $169,847 portfolio as of 10/26, and they all declined by 10% (thus also causing a 10% decline in the DJIA) that person would lose $17,094. These figures are only as of the first circuit breaker.