April 30 (Bloomberg) -- CBOE Holdings Inc. said preliminary work in preparation for reconfiguring its computer systems caused the April 25 malfunction that shut the Chicago Board Options Exchange for three-and-a-half hours.
The company was preparing to change its systems to get ready for extended trading hours on the CBOE Futures Exchange and eventually CBOE options, the exchange operator said in a letter to customers posted on its website yesterday. That work “exposed and triggered a design flaw,” it said.
“Early Thursday morning our team identified and addressed a potential software issue and subsequently believed we were on track for a normal open,” the company said in the letter from Chief Executive Officer Bill Brodsky. “Unfortunately, the nature of a software bug is sometimes only identifiable once the system is operationally ready, such was the case last Thursday at CBOE. As we approached the open, it became apparent that the software issue was not fully resolved, and the decision was made to delay the opening.”
The CBOE’s shutdown underscored how common technology errors have become among the exchanges that dominate the world’s largest financial market. While most equity-derivatives contracts are traded on multiple exchanges, CBOE is the exclusive venue for options based on the Standard & Poor’s 500 Index and the so-called VIX gauge of equity volatility.
Buy and sell orders for options on stocks and exchange-traded funds flowed to the 10 other U.S. options markets. CBOE accounted for 8.4 percent of U.S. options trading on April 25, compared with 23 percent the prior day, according to data compiled by Chicago-based Options Clearing Corp.
The outage frustrated investors still shocked from a swoon in the market on April 23 that briefly erased $136 billion from S&P 500 stocks after a hacker sent a fake post from an Associated Press Twitter account saying there had been explosions at the White House that injured President Barack Obama. Traders and analysts at firms including Aite Group LLC and Conifer Securities LLC said the dip may have been exacerbated by computer algorithms that read news feeds.
The Securities and Exchange Commission proposed a mandate in March directing exchanges to strengthen their technology and instruct member firms to participate in tests to show they can sustain operations after a widespread disruption such as a natural disaster or terrorist act. The planned rule, called Regulation Systems Compliance and Integrity, seeks to limit technology breakdowns at venues handling stocks, options and bond trades and ensure they can withstand malfunctions that could jeopardize markets.
Regulation SCI will replace the SEC’s Automation Review Policy guidelines, developed in 1989 and 1991 after the 1987 market crash known as Black Monday, when the Dow Jones Industrial Average plummeted 23 percent. Codifying voluntary guidelines to ensure the resilience of exchanges and the broader market and expanding them to larger broker-owned dark pools will protect participants in the complex, interlinked network of competing venues, the SEC said.
Brodsky and Ed Provost, CBOE’s chief business development officer, were at a Las Vegas resort for the annual Options Industry Conference on April 25. The conference marked the 40th anniversary of the CBOE, which was founded in 1973 when exchange-listed options were first traded in the U.S.
The SEC was monitoring the situation “as is our practice,” spokesman John Nester said that day.
Shares of CBOE finished the April 25 session up 16 cents, or 0.4 percent. The stock gained 1.4 percent to $37.04 yesterday and it is up 26 percent this year.
CBOE said its internal review of the “software bug” is now complete and the exchange conducted extensive testing and re-testing of its systems over the weekend, according to the letter. The outage wasn’t caused by a systems upgrade or new systems load, it said.
The company plans a detailed analysis on its response and procedures during the disruption, the letter said. It will study how to reduce the time required to resume trading if another error occurs, CBOE said.
Two additional abnormalities resulted from the malfunction. Auction mechanisms for options products on CBOE weren’t available to market participants on April 25 and some trade data from that day was erroneously resubmitted to the Options Clearing Corp. at the close of trading on April 26.
The CBOE’s breakdown is the latest in a series of computer malfunctions that have rattled exchanges and trading firms in the three years since a firm’s aggressive use of an algorithm trading futures triggered the so-called flash crash on May 6, 2010, that briefly wiped out $862 billion in market value in less than 20 minutes.
In January, Bats Global Markets Inc. acknowledged that computer issues allowed about 12,000 trades that violated rules intended to ensure all investors get the best prices for equities, 10 months after it canceled its own initial public offering because it couldn’t get the stock to trade on its exchange. Knight Capital Group Inc. almost went out of business in August as a result of improperly installed software. Charges related to Nasdaq Stock Market’s bungled Facebook IPO prompted Nasdaq OMX Group Inc. to set aside $10 million for an SEC probe as well as $62 million as compensation to brokers that lost money in the stock’s debut.
A power failure shut the CBOE for 35 minutes in August 1999 and a computer malfunction halted trading for about two-and-a-half hours in February 2000. The exchange’s systems malfunctioned in November 2007 and disrupted trading for about an hour.
To contact the editor responsible for this story: Lynn Thomasson at email@example.com