Nassim Taleb didn’t cause the crash

By Felix Salmon
May 11, 2010
give particular credence to the idea that it can all be traced back to a single $7.5 million trade for 50,000 options contracts. Lots of options trades of that size take place every day, and just because this one happened just before the market fell doesn't mean it was the cause of the crash.

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Of all the silly theories about the cause of Thursday’s stock-market plunge, I’m not entirely sure why the WSJ has decided to give particular credence to the idea that it can all be traced back to a single $7.5 million trade for 50,000 options contracts. Lots of options trades of that size take place every day, and just because this one happened just before the market fell doesn’t mean it was the cause of the crash.

It’s becoming increasingly clear that the crash was fundamentally the fault of weak market structures, especially in the smaller electronic exchanges. It wasn’t a fat finger, it wasn’t cyberterrorism, it wasn’t the sale of 16 billion e-mini S&P contracts rather than 16 million — and it wasn’t an options trade by Universa, either.

When your hard drive fails, you don’t ask for the proximate cause of the failure: even if such a thing existed, which it doesn’t in any meaningful sense, knowing what it was really wouldn’t help. The important thing is that your hard drive is prone to fail and therefore it’s a good idea to have redundant systems and make sure that when it fails, no great harm is done.

So let’s not start pointing fingers at Universa, Nassim Taleb, or anybody else. The thing to look at here is the way the entire market is designed, not the identity of any given trader.

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Comments
13 comments so far

But identifying culpable traders could be an effective part of redundant market design…

Posted by Wismar | Report as abusive

I didn’t take the article as pointing fingers at Universa at all; if anything, it was a final stake in the idea that the problems were caused by a ‘fat-fingered’ trade. If the trade that broke the market was a reasonably sized, intentional trade of the kind that the market is intended to handle, then the problems are structural.

Posted by MattJ | Report as abusive

This whole idea that the ‘Crash of 2:45PM’ was caused by a fat-fingered typo never struck me as plausible. Nonetheless, for 99% of the general public who wouldn’t know the difference between a bond and a debenture, such an explanation is readily understood and then forgotten a day later. Felix has it right – why it happened isn’t important. Just make sure it doesn’t happen again.

Posted by Gotthardbahn | Report as abusive

The more complex the system, the greater the probability of failure.

Posted by LucidOne | Report as abusive

The numbers in that article is wrong as well. To make $4 billion if the S&P were to fall to 800, you’d need 50,000 puts with a strike of 1120 (the multiplier is 250). There’s no way those were sold for $7.5 million, or 150 per contract. For $150 per contract you’d get 770 puts or thereabouts. Now this would be in keeping with Taleb’s strategy of buying lotteries, but they’re out of the money at 800. The position limit on S&P options on the CME is 20,000 contracts.

50,000 e-minis would give you 1/5th of the exposure (equivalent to 10,000 regular contracts).

Posted by The_Governor | Report as abusive

Felix, I was wondering when someone would say this! . .
Seems such emergencies are times when people go looking for all sorts of hatchets. I wonder though if Nassim was able to exit his trade. They never mentioned that!

The much much bigger mystery than what caused the meltdown, in my mind, is what caused the almost immediate melt-back-up? Any ideas?

I don’t think market forces took care of it. If anyone’s interested I posted my ideas about this at:
http://ravenofferings.blogspot.com/

Posted by firstbridge | Report as abusive

It was obviously the ghost of Bertrand Russell gently reminding the world that panic is not the correct response to observing your first black swan. (The Problems of Philosophy, 1912)

Posted by Ian_Kemmish | Report as abusive

It is absolutely absurd to recommend fixing a problem of this magnitude (800 Billion wiped out in 15 min) without knowing its cause as well.

We are in a world of increasingly sophisticated technologies and fixing problems in hindsight is reactive and proactive.

You would think someone would care enough if the stock market collapsed due to such technicalities and to proof the systems against other “potential” disruptions.

Anything else is totally unacceptable and just plain stupid.

Posted by Marcus180 | Report as abusive

Oh they know, they know. They’re just not telling us.

Posted by Woltmann | Report as abusive

Complex systems often have multiple semi-stable states. In something as complex as the stock market the chance that a small trade triggers a jump from one semi-stable state to another is not that ridiculous. Ask yourself this – if the stock market dropped 9% over a year would you consider that a glitch? From a system analysis perspective that’s not that different from it happening in a minute, especially given that these very complex instruments and electronic trading make the “momentum” of the system very low.

Posted by nicfulton | Report as abusive

Can we stop talking about the crash. So yesterday’s news…

Gold will be coming back down once Europe calms down. Then get back in through an ETF because inflation is coming in 2011

http://storyburn.com

Posted by STORYBURNcom2 | Report as abusive

Felix, you’re on the right track of ‘lets get rid of the criminalization, and recriminations’, but your analogy is off a little. If my hard drive fails, I can certainly fix it. Either by replacement, or remanufacturing (and then making sure my manufacturing process fixes this flaw also). But before fixing a problem, the origins of the problem must be known… Otherwise you’re whistling in the wind…. :)

Posted by edgyinchina | Report as abusive

I was wondering when they were going to get around to blaming this problem on the options market, when they ran out of other people to blame.
If anything, I was trying to trade index options when the thing started to crash and, I’m assuring the index options market protectively self-shut-down as I couldn’t get a quote, a trade, anything for 15 minutes.
So go find someone else to blame.

Posted by tawand | Report as abusive
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