The chairman of the Securities and Exchange Commission said yesterday the agency will take a new look at computerized stock and futures trading techniques with an eye toward restricting their use when the market is unusually volatile.
The controversial trading methods known as program trading, portfolio insurance and index arbitrage require buying and selling blocks of as many as 500 stocks at once, while simultaneously making similar trades in stock index futures or options.
"We are going to be looking at program trading to try to determine if there are regulatory steps that might be taken," said SEC Chairman David S. Ruder in his first press briefing of the week.
Ruder said there was "a significant amount of program trading on Monday morning" when the stock market's wildest week began, and the practice continued even after the New York Stock Exchange took steps to limit its use.
Ruder said the SEC's inquiry will extend to the Chicago futures markets, which are now outside the authority of his agency and regulated by the Commodity Futures Trading Commission. "We are very anxious to see what was going on here," he said. "We certainly are going to look at commodity futures trading's influence on the market."
The commodity markets trade stock index futures contracts, which let speculators bet on the overall direction of the stock market by buying contracts for future delivery of all the stocks included in such popular market indicators as the Standard and Poor's 500 stock index. Traditionally the futures markets have jealously guarded their independence from the SEC, which has a reputation for much tougher regulation than the CFTC.
Ruder did not challenge the usefulness of stock index program trading, saying "it does have a positive economic function in hedging," or reducing the risk of stock market investments.
But he said the events of the past week suggest that hedging may not work as well as expected and the negative effects of index arbitrage may outweigh its benefits when the markets are swinging wildly up and down.
Some big investors may have held onto their stocks even though they recognized the stock market was getting more risky, thinking they had hedged their bets through program trading. But hedging didn't provide much protection in such a volatile market, Ruder explained.
"There was an expectation of protection from the hedge position," he said. "If you have a large position and expect to be protected, you may be more heavily invested.
"It might be," he added, that investors "felt more confident about this protection than was actually available."
He said the agency will study whether index arbitrage trading gone awry made the stock market even more unpredictable this week. "One has to go back and ask whether techniques in the market that are useful in ordinary times are useful in very difficult situations."