Trading Halts in the Market

A conversation with Gary Selz , my friend who runs an Options Fund of Funds sparked the idea for this article.

Trading halts protect investors and traders alike but during volatility pauses, they can impact traders hoping to quickly monetize their positions due to a halt in trading in the underlying. We recently saw this following the collapse of the yen carry trade and the reverberating effects in the US equities market resulting in increased volatility.

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·??????? - When do volatility pauses happen?

When markets work efficiently with adequate supply and demand, underlyings and options trade with liquidity and volume ebbing and flowing. However, when there is an increase in demand and supply does not increase and vice versa, price volatility can swiftly be introduced.? These significant moves over a short time horizon (5-minute window) can result in a breakdown of price dissemination, resulting in floor and executing brokers being unable to deliver accurate pricing and causing trading to halt on the name. According to Trading SIM this “circuit breaker” generally trips “between 5-10% for Tier 1 stocks and 10-20% for Tier 2 stocks” for both moves to the upside and the downside.

The triggering of a Code LUDP results in a trading halt for 5 minutes. Upon reopening, more 5-minute halts can be instituted during a given day. A great example was the volatility spike on Monday, August 5, 2024, halting the trading on certain single names and ETFs alike. Although trading halts serve as an important bulwark to ensure pricing transparency across brokers and exchanges, they can prove disastrous for traders hoping to monetize in tail price-swing scenarios.

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·??????? - How can the impact of these be mitigated?

Counterintuitively, trading halts can increase single security volatility as the coin flips from a buying frenzy triggering the pause to a selling frenzy as traders’ stop loss orders are filled, buyers flip to sellers, and the supply balloons, depressing the price as traders attempt to crystallize gains. Hedge diversification is an important piece of a manager’s portfolio as these hedges allow for monetizing a profitable thesis with a decreased risk of a trading halt associated with a concentrated hedge position.

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·??????? How do operations fit into this?

As an operations professional, understanding the composition of the portfolio is paramount. Although you may not be making investment decisions, informing the investment team of tail risk outcomes is an important value-add to your team. Trading halts and volatility pauses are important pieces of the investment puzzle for you to be aware of to ensure that gains generated by the investment team can be realized. In the emerging manager, the buck stops with the COO regarding trade execution and settlement. Understanding how the tails of trade execution play out can make or break period performance.

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Insights from: https://www.tradingsim.com/blog/stock-halts-and-circuit-breaker-halts-explained

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None of this should be construed or interpreted as investment advice. This piece was written EXCLUSIVELY for informational purposes and should NOT be relied on for anything other than that.