A major player in the trading world curtailed its trading of a major index in response to widespread spoofing by 3 Red Trading.
Richard May, who has been with Citadel Trading since 2004, made the stunning claims in an affidavit dated October 8, 2015.
Who is Citadel LLC
According to May, Citadel LLC (limited liability corporation) is a global financial services conglomerate which“trades in over 30 countries, including many of the most liquid financial markets in the world.”
May noted that Citadel had, as of the affidavit, employed 1,400 worldwide, including 700 in Chicago.
Unlike 3 Red Trading- which is a proprietary trader and trading in its own account- Citadel manages money for others.
Citadel and the E-Mini S&P 500 futures contracts (ES)
According to May, Citadel was specifically a major player in ES, “Citadel is consistently among the top five traders by volume of executed transactions in the E-Mini S & P 500 contract (ES), which is traded on the Chicago Mercantile Exchange (CME). By offering substantial liquidity to that market, there are more opportunities for people who want to acquire these futures to do so. Also, providing liquidity helps keep prices tighter (or spreads narrower), which benefits all market participants.
“WE consider ES a critical benchmark and the most important pricing input for Citadel Securities’ futures and equities business. In fact, Citadel used pricing and trade data form the ES market to forecast future price movements for many strategies used by the firm throughout its trading globally.”
The Spoofing of ES
Spoofing occurs when a trader enters order they do not intend to execute but rather are used to drive a security’s price in a certain direction temporarily; the orders are quickly cancelled after the price change is accomplished and order- which are executed- are often placed on the other side at the manipulated price.
There appears to have been a spoofing assault on the ES which trades on the CME. As The Industry Spread has exclusively report, 3 Red Trading has been cited at least six times by exchanges on multiple continents for spoofing activity and namely by the Commodities Futures Trading Commission for spoofing the ES.
Here’s part of a CFTC press release from December 2016: “The U.S. Commodity Futures Trading Commission (CFTC) today announced that Judge Amy J. St. Eve of the U.S. District Court for the Northern District of Illinois entered a Consent Order of Permanent Injunction (Order) against Defendants Igor B. Oystacher and his proprietary trading company, 3Red Trading LLC (3Red), both of Chicago, Illinois, finding that the Defendants engaged in a manipulative and deceptive spoofing scheme while trading at least five different futures contracts on four exchanges for more than two years, which violated certain provisions of the Commodity Exchange Act (CEA) and CFTC Regulations adopted pursuant to the CFTC’s anti-spoofing and expanded anti-fraud and anti-manipulation authority under the Dodd-Frank Act.
“The Court’s Order stems from a CFTC Complaint filed on October 19, 2015, charging Oystacher and 3Red with spoofing and employment of a manipulative and deceptive device while trading E-Mini S&P 500, (emphasis added) Copper, Crude Oil, Natural Gas, and VIX futures contracts.”
An industry source said that 3 Red Trading trades as much as half the volume on the CME in a given day.
A joint announcement earlier in the week by the CFTC and the US Department of Justice included charges against an Australian trader named, Jiongshen Zhao, who was also accused of spoofing the ES.
“The third case charges Jiongshen Zhao with various spoofing and fraud offenses, along with making false statements to a registered entity, the Chicago Mercantile Exchange.
“As alleged, Zhao – a trader at a proprietary trading firm located in Sydney, Australia – manipulated the S&P 500 E-Mini futures market in hundreds of individual episodes between approximately 2012 and 2016, by employing an illegal spoofing strategy.”
It’s noteworthy that the presence of the US DOJ in Zhao’s case means he faces prison time, something Oystacher does not currently, even though the amount of spoofing he’s done dwarfs that of Zhao.
Dennis Holden, public affairs officer for the CFTC, declined to comment.
Chris Grams, public affairs officer for the CME, also declined to comment.
An email to the public affairs office at the US Department of Justice was also left unreturned.
Citadel Discovers the Spoof
May said he was working as a quantitative researcher in their market making division in September 2013 and here’s what he said happened when he noticed the firm’s ES performance deteriorate. Citadel used algorithms to trade the ES. Approximately three in four trades are now made using algorithms.
“I noticed a decline in Citadel’s trading performance (profits and losses) in ES and I became concerned that our algorithms were no longer forecasting price movements the way we expected.
“Beginning in September 2013 through December 2013, I, along with another employee who reports to me, started looking into the trading data to determine what happened. First, we used a program to analyze statistics related to the size of orders, which was unusual and inconsistent with the conduct that we previously observed in ES.
“By further reviewing the data manually and with the help of software programs that we created, we identified a pattern in which a trader entered disproportionately large orders in the order book that, in the aggregate, often constituted 25% to 50%, of the resting orders in the top several layers of the order book.”
May continued: “Next, we observed that, all within a few milliseconds: 1) a large number of orders would be removed from the top level; 2) there would be a large trade for the remainder of that level; and then 3) a large quantity of orders in the opposite direction at the same price would appear in the order book.”
May called what Oystacher was doing a Pull/Swipe strategy: “In the Pull Swipes that I observed, the cancellations were followed by an aggressive order at the same price in the opposite direction within a few milliseconds, which was less than the time it took us (and all other market participants), to send an order in response to the cancellations.”
May said he then led a team of Citadel employees “to develop a program to help identify when the spoofer used the Pull Swipe strategy in ES.” May continued, “Once we completed the program by December 2013, we ran the Pull Swipe Detector through the historical CME data in ES that we had stored in-house going back to the Spring 2013. We noted that the spoofing pattern stood out in June 2013 in addition to September through December 2013.
“We then ran the Pull Swipe Detector frequently during December 2013 and January 2014 because the spoofing activity was significantly impairing the operation of our trading strategies and we were concerned that the markets were being manipulated”
May said as a result, Citadel cut back on its ES trading: “We always want to trade on orders we put in the market, but we cannot do so profitably when the order book does not reflect genuine interest. Teams of employees spent many years working, and the company invested heavily in, designing these strategies but we had to put that work on the shelf and scale down our market participation to account for the presence of the spoofer.”
May said he also brought his information to the CFTC and the CME.
A voicemail left at 3 Red Trading was left unreturned; that company has not responded to numerous requests for comment on this ongoing investigation.
Zia Ahmed, Director of Corporate Communications and Global Head of Media & External Relations – Citadel LLC, declined to comment or provide May for an interview.