The Plunge Protection Team

Safe Haven | Frontline Thoughts ^ | April 5, 2003 | John Mauldin

[sourcery]

I have had so many letters of late asking me what I think of and/or know about the existent of the so-called Plunge Protection Team, that mysterious group of government officials who secretly prop up the stock market when it drops too much, that I am going to jump in where wiser minds would just leave the subject alone. It will offer a good opportunity for you to understand concepts of arbitrage and how the markets really work. Plus, if you can prove me wrong, I will show you how to get a quick $100,000.

Following the stock market crash in 1987, the government created something called the President's Working Group on Financial Markets. The group, which includes the Treasury secretary, Federal Reserve chairman, chairman of the Securities and Exchange Commission and chairman of the Commodity Futures Trading Commission, was formed to ensure the smooth operation of financial markets.

Citing a Washington Post article, Carol Baum recently wrote about a 1997 article: "The Working Group's main goal, officials say, would be to keep the markets operating in the event of a sudden, stomach-churning plunge in stock prices -- and to prevent a panicky run on banks, brokerage firms and mutual funds..."

"The thrust of the article is official's efforts to avert a liquidity crisis, which is exactly what the Fed did when it flooded the banking system with reserves following the 508-point plunge in the Dow Jones Industrial Average on Oct. 19, 1987. How an effort to ensure adequate access to credit to prevent a domino effect in the event of market meltdown morphed into a cabal to prop up the stock market is anybody's guess. For a window into the depths of the conspiracy theory, type "plunge protection team" into Google and see what comes up."

Every time the market drops and then "mysteriously" rallies, knowing individuals look at each other and nod, seeing the handiwork of the PPT (plunge protection team).

Let's say it straight out. The plunge protection team does not exist. It is an urban myth. Let me step by step prove it does not exist, and see if we can learn something in the process.

Supposedly the PPT manipulates the market by buying S&P 500 and DOW and NASDAQ futures when the market is dropping. Somehow, this supposedly forces the market back up. The problem is that buying futures cannot drive the stock market, which is obvious to real traders.

I talked with a few good friends about this article prior to writing it, to get some background and ideas. Art Cashin, of CNBC fame, and one of the real veterans of the markets, who ahs seen it all, wrote me the following very clear thoughts:

"Suppose you have a lot of cash and would like to buy the S&P Index. In the old days (circa 1980), you had two choices. You could buy each of the stocks in the S&P according to its weighting. Then you would own a "basket" of the 500 stocks. Or you could buy an S&P futures contract on the S&P. Which should you choose?

"If you bought the 'basket' of stocks, you would get whatever aggregate price improvement (or loss) that occurred while you owned the basket. In addition, you would get any dividends paid. A slight negative would be that it required 500 transactions (1 for each stock) and thus 500 commissions.

"If you bought the "futures," it would give you similar price action since it would mirror the ups and downs of the basket and the index. A negative would be that you would not get the dividends. Positives would be a single transaction with more favorable margin requirements.

"By constructing a formula of the variables - total dividends, time left to expiration and interest rates, etc. - you can determine if one of these choices is cheaper than the other. This is called arbitrage.

"An old example of arbitrage was gold. If gold was selling at $300 in Paris and $350 in London, one Rothschild might send in a pigeon to another Rothschild suggesting A buy in Paris while B sold in London allowing the firm to pocket the $50 (less transportation and currency conversion).

"The futures/basket formula gives you equilibrium or Fair Value. If stocks (the basket) go up faster than the futures, you might sell the expensive stocks and buy the cheaper futures. If the futures ran faster then you would, do the opposite. This is called index arbitrage or sometimes program trading....

"Anyway, the arbitrage between baskets and futures is now much bigger thanks to the addition of Exchange Traded Funds (ETF's). So now you can "arb" the basket against the futures or the S&P Index (ETF) (or any combo thereof). It is a huge market."

* Trading desks do arbitrage program trading for a fraction of a percent on a trade. Any attempt by the Fed to manipulate the market would just make a lot of money for hedge funds and trading desks.

* The amounts of money required to attempt such a manipulation would be huge. We are talking tens of billions of dollars if there was a true collapse going on. The collective size of the trading community in the world (hedge funds and "prop" desks - a prop desk is a proprietary desk for an investment bank or broker-dealer) is in the multiple hundreds of billions. It would require the willingness to lose billions of dollars every time you took the plunge, so to speak.

* If the Fed or Treasury or some slush fund did buy stocks, it would inject liquidity or more total money into the financial system or money supply. Since the Fed openly manipulates the money supply every day in transactions that everyone can see, in order for the Fed to hide the activity of the PPT, they would have to take out liquidity by selling treasury notes. Otherwise, the numbers at the end of the day or week would not add up, and someone would notice. But if they were taking out liquidity and the money supply did not go down, then someone would know something was up. You can't hide these numbers, unless you can get a lot of clerks at the Fed and elsewhere to agree to lie.

* You could not keep something of this size secret. Period. The orders would have to be entered somewhere. The theory is that Goldman Sachs or Citibank (or pick a firm) is part of this conspiracy. That means that multiple traders and officers would have to be in the know. You cannot mask trades of that size because it would essentially be the largest hedge fund in the world. Someone would spill the beans. Can you imagine the signing bonus from a book publisher if you could prove the existence of the PPT?

I hereby offer a $100,000 advance against 50% of the royalties to anyone who can "show me the trades." Give me names and dates. I will write the book, and we both become famous.

Further, can you imagine what political hay the opposition political party would make of the proven existence of a PPT? Do you think that the Dems wouldn't love to embarrass Bush with "proof" of his manipulation of the market? Can you imagine Newt Gingrich or Tom DeLay (Republicans) not beating up Clinton and Robert Rubin for crimes against the market and for losing billions of dollars of tax-payer money?

If the President's Working Group was really the PPT, do you think every former SEC and CFTC Commissioner (and there are maybe a dozen) would all keep silent after they are out? Do you think their wives (or husbands) would not tell all in a divorce hearing? Do you really think that if Harvey Pitt would have allowed George W. to fire him if he could blow the whistle?

A Hedge Fund's Secret Wish * I don't doubt there are all sorts of secrets that officials in our government keep from us, and that all sorts of untoward things are done every day in the government, that if we found out we would be shocked.

But if the PPT existed, it would be just too big to keep secret. If it were small enough to be secret, it could have no effect upon the market. I don't doubt for a second that if the Fed decided to buy stocks and was willing to risk losing hundreds of billions, they could move the stock market up for a period of time. But then what do they do? They own a bunch of stocks. Could they ever sell without causing a crash?

Furthermore, if there is a PPT, they are the most incompetent team in the world because the markets have indeed plunged. I can guarantee you this: it is every hedge fund's most fervent wish that there was a plunge protection team, because it would be a license to print money trading against them. Imagine, having someone on the market with an unlimited bank account whose objective was to lose money? Could it get any better?

Some would argue that the PPT does not lose money - that they are so good they buy the stocks and wait until the market goes back up before they sell. If there were individuals who had such god-like insight into the future direction of the market, they would be running their own funds, making tens of millions in annual fees, far more than they would make as a bureaucrat. Further, as the bear market has moved the market down, the losses would be in the hundreds of billions by now. That much loss cannot be hidden, even if you have a printing press.

* If you believe in the PPT, it probably would do no good to mention that the rules under which the Fed operates makes it illegal for them to participate in such an operation, since you would assume they would not follow their own rules.

Let's look at the Crash of 1987. At the end of the day, there was a huge amount of futures buying, which some say is evidence of the Fed or other group stepping in and stopping the bleeding. What really happened is that the futures got so out of whack with the physicals that it was an obvious arbitrage position, and Paul Tudor Jones, one of the largest and certainly one of the more highly respected traders stepped in and began to cover his huge short position. Jones was a legend. Once the word hit he was covering, the crowd stormed in. No conspiracy. No hidden machinations. Just some traders taking monster profits.

And that often is what you see when there are large and strange moves. Just traders taking profit, either on the long side or short side. It is what Chris Fuligni calls his TFTF trade: Too Far Too Fast. When the market moves too much in one direction, traders take profits.

In my opinion, and as I have made the case for several years, this market is too high compared to historical trends of value. In my opinion, it has much further to go on the downside. But secular bear markets do not go straight down to "fair value." It takes years of going down, with large rallies back up and then more down before the bottom is finally reached. At every step, there are advisors and investors who decide that "now" is a good time to invest. There is no mass consensus.

Remember, over half the years within a secular bear market cycle are up years, and most of those are up by 20% or more. As the fairly bearish Dan Denning wrote in Strategic Investment today: "...confidence can be a heady thing. If Hussein ends up dead and Osama bin Laden is captured, look for 10,000 on the Dow in short order. Euphoria is a powerful emotion."

Those who feel the market is over-valued have ample justifications. You can go to Standard and Poor's website and look at their valuations. If you take pro forma earnings (that is Earnings Before Interest and Hype) the current P/E ratio is 18, which is high, but certainly within historical norms. But if you look at actual "as reported" earnings, the P/E ratio jumps to 30.29. That is in nose-bleed territory to the historical average of 15.

If you look at core earnings, the number is over 35. Core earnings subtract options expense and pension fund overstatements. The new accounting standards will probably mandate firms to start subtracting these items, so the core earnings P/E ratio is a number that is increasingly going to be seen by the investor.

Not fair, say the bulls. To get true historical comparisons, you have to compare apples to apples. The new standards distort the actual profitability of a company, and give us no fair historical comparison.

To that, I politely say bunk. Pre-1990, pension benefits did not have nearly the impact that it does today, as there was not that much over-funding and estimates of future earnings were far more conservative. It is only in the decade of financial engineering, where a CEO could create a 10% rise in his company earnings just by changing the assumptions of his company pension fund that these elusive pension fund earnings started to show up in the books in a significant way.

Of course, that helped the CEO's personal options, which again the company did not have to expense. Options were not a big deal prior to 1980 and not all that significant even until 1990.

Accounting standards always tighten up in bear markets. Investors become more conservative. They are not willing to project earnings growth far into the future. That is why the market drops.

If you go to Decisionpoint.com, you can see in one of the many hundreds of charts available that if the P/E ratio for the S&P 500 were 15, about average for the last century, the market would be at 420 today. As markets have always over-corrected, generally to below single digit P/E ratios, if it went to 10, the S&P 500 would be at 280, down 68% from here. That is pretty ugly.

I believe we are going to single digit ratios. I also believe it will take a decade or more. In that time, earnings will grow, and probably double or more without having to be too optimistic. What happens in secular bears is that earnings grow and P/E ratios drop. But it does not happen all at once. It takes time.

We can be thankful for that, because if the markets were to drop 68% today, we would be facing a depression as severe as our grandparents faced. It would be ugly, ugly, ugly. Thus, in a kind of perverted logic, we should be grateful for market cheerleaders, as they prop up the economy and stave off a disaster scenario. But as individuals, we don't have to listen to them.

The point is that there are those who see the market as under-valued. When it does not go up they blame hedge funds, short sellers and wicked analysts for their losses. There are those who see the market as over-priced and want the market to conform to their worldview, and they see rallies as evidence of the Plunge Protection Team. The world is not as it should be, and there must be some secret reason. That is especially true if they are short and the market goes up.

The real reason is what Richard Russell says over and over, "The market is the market. It just is." In a real sense, this is more scary than the possible existence of a plunge protection team. It means we are subject to the vagaries of a market which is out of anyone's ability to control. I bet there have been a few times you wish someone could have made the market go back up. In a world where anything can happen, risk control is everything. It would be nice to know that I could count on some secret group to protect my funds, but it doesn't exist. I am responsible for my own risk protection and personal portfolio.

Randomness and Responsibility Thus, we return to Art Cashin's final bit of wisdom: "People can't stand two things - randomness and responsibility. On the first point we again cite Voltaire: "If God did not exist, it would be necessary to invent him." The premise is obvious and a truism - life must have order. The class needs rules and a teacher. An occasional accident is acceptable, though maybe not understandable. The logical (for many of us) existence of a deity transmutes in the secular world into - someone is in charge. (The government, the moneyed interests, some religious or ethnic group, etc.)

"Now factor in the inability to accept responsibility.

"If my horse doesn't win - the race was fixed - the horse was doped. The variations are myriad. It can never be my fault or my miscalculation. That could mean I was careless, or confused or hasty or maybe even wrong. The latter is unacceptable so it must be someone else.

"Thus conspiracy theorists and the plunge protection theme. In four decades, I've heard hundreds of theories. The collapse of the Hunt Brothers' silver bubble was roundly blamed on a government conspiracy. As time went on it was obvious there was no conspiracy - not there or in hundreds of other cases. But....when your perfect game is ruined in the final frame (bowling) or the final inning (baseball) - dashed hopes demand a villain - an evil deus ex machina. They stole it from me, I tell ya!!"

Time Out It is late on a Friday evening. I have had more distractions on my Friday e-letter writing afternoon than any time in recent memory. There are a dozen other topics that deserve mentioning. Steve Roach of Morgan Stanley now predicts the world will slide into a double dip recession as the SARs virus hits the world economy. Housing remains strong, yet the IMF warns of a bubble in housing. Dennis Gartman reports shipping rates and shipping is up, which means world trade may be improving. Unemployment is up, manufacturing is down, and the service industry is in contraction mode.

In short, it does not look good for my Muddle Through scenario. While I clearly think we will have another recession, at the beginning of the year, I thought we could avoid it for 2003. Now, I seriously have questions about that prediction. And yet, the economy will probably have grown a little more than 1% in this last quarter, and it looks to do so in the second quarter. Could an end to the war create that euphoria Denning mentioned. Stay tuned, as I will just have to address this next week.

Speaking of conspiracies, my Dallas Mavericks lost to the Lakers last night. I was right down front, and I can tell you that there was clearly a conspiracy among the referees to allow Shaq to get away with anything. You could see them looking at each other. I saw all sorts of winks and hand signals. We were robbed.

Your ready for the weekend analyst,

John Mauldin

[zechariah]

By "professional," I meant someone whose primary income is generated from market operations involving his own capital (by which I mean profits on trades, not receiving a salary or commission for acting as a trader using someone else's money.)

I thought market makers made money by pairing buyers and sellers where the the buyer pays a bit more than the seller sells for and the marker maker pockets the difference. How does that involve "his own capital"? Do market makers routinely accumulate stocks by buying more than they sell?

The difference between this case and the other cases is that no one buys and sells stocks as a way to hedge against price changes in the market in which they do business. The closest one gets is those who buy and sell stock index futures. Anyone who does this in order to hedge stock positions held as a necessary part of the operation of their business would be considered a commercial trader of stock index futures. When someone talks about the net long or short position of commercial traders in the stock market, what they are actually referring to is the net positions of those traders in the stock index futures market.

Ok, so what keeps the commerical traders from being wrong?

[z]

[zechariah]

There are three central problems for market manipulators:

This makes perfect sense.

And prices move in synch with the actions of the professionals and commercials, who control the price because a) they are the "strong hands," who can afford to be patient, and b) because of the volume of trades they can execute.

See, this is what bothers me. Why don't your "three central problems" for market manipulators apply to the the "strong hands" whom you claim are able to "control the price"?

[z]

[imawit]

Excellent article and excellent discussion.

Since us guys don't have the wherewithall, we can't arb or play the spreads I guess we just have to buy low, sell high.

The markets are pretty whacky right now, TA and fundamentals are not able to do the job of prognosticating. Anybody got a line in to God ? Or a line into that guy or team who keeps destroying my plays ?

Or there is that 3rd factor, anybody got a line into the market psychologist.

All kidding aside, there are the factors of the financial and monetary policies which have a huge influence on the markets yet at the moment the economy and those policies are having little to no effect and yet they are with the actuals.

Very interesting times, huh Richard.

[arete]

Very interesting times, huh Richard.

Yes they are. Now I'm back to square one again -- that's where I'm trying to figure out how all the pieces fit together or even if they do. I'm also staying "flexable" and open minded.

Richard W.

[arete]

Here is an interesting editorial by Nelson Hultberg regarding the PPT. It is speculative theory but it presents a different view. The only thing that I would like to personally add is that in my own view, it would be a mistake to underestimate both the power and the willingness to use that power, of the FED, the gang of 22 and the power elite of Washington.

CORNERED RATS AND THE PPT

Richard W.

[imawit]

Well here's my 2bits or may its just 2 bits more or less 2 bits.

There is program trading on the weighted stocks. You can see that by the fact that the index on the DOW & NAS both have an up tick or both have a down tick at the same time and are of such magnitude that these ticks (vectors) can easily be seen on the two indices simutaneously.

Second, the spread trading between the futures and the stocks does occur. So if some one (the big dogz) put some time and money into it, I'm sure that could set up a program that tracks the two and rings a bell when the spread indicates a good time to set up and play the spread. This is hard for others to read because no one is able to see which stock and appropriate future are being played this way unless you know the guy actually doing it. With gold, it's easy to see. One future and just a handful of stocks.

Thirdly, the big dogz have the power to push a given stock or future the way they want. Take gold as an example.

Fourth, in the short term, hours to a few days, prices can be manipulated but over the long term, the Market is the final arbiter.

How else did we get the 90's bubble and now the out gasing. Optimism, Exuberance, negativism. These are functions of the monetary and fiscal policy. The boom/bust or bust/boom if you will. Things go so far in one direction that they reach a point of unreality and then turn in the other direction. Each given trend also has an overshoot phenomena. And then there are the bear rallys in a boom market and the bull rallys in a bear market.

Another factor is inflation. This is always a boon to the top of the food (money and wealth) chain and debilitating to the lower end (no money & no wealth).

I could go on and on and on. The number of games and ruses that can be played are innumerable. So us chicken littles just have to somehow make sure we don't come up with the idea the sky is falling and to be in the right place when the dice stop rolling.

Or, don't be in the game at all. In, out or above it all. That may be more fun or no fun at all depending on one's outlook.

[imawit]

CORNERED RATS AND THE PPT.

Does anyone doubt the Rubin/gold scenario of this editorial ? Definitely gold and silver are not at a free market price at this time.

As for the PPT, events do champion its existence. The actual proof will turn out to be an absolute disaster. And then again should there never ever be any proof, ...

HOW do we continue to increase the amount of money and debt forever without a pull back. Reflation will not occur with low rates and more liquidity if debt starts to get paid off and the average flow of money does not go into chasing more goods causing higher inflation. Then, what after that, should that occur.

The markets and the populace WILL be the final arbiter and I don't think any fiscal, monetary or manipulative schemes can control the public and its pocket books. After all, how many new cars and million dollar bungalows can we buy ?

Are the 04 models out yet ??? I understand they'll be much snazier, put all prior models to shame and cost you less but have a higher sticker price or is that cost less at the sticker and less per month over the next 6yrs of the contract with no down, no interest and no payments for 2yrs. I think I'm going hook, line and sinker on this new model.

Or maybe it's that million dollar bungalow over in the next neighborhood. 2% now for five years then higher rates later but I can sell in 3yrs and move up. WOW !

[hripka]

See the "Futures only Commitments of Traders Reports" (all exchanges) at
http://www.cftc.gov/cftc/cftccotreports.htm

Chicago Board of Trade (Long Form) at
http://www.cftc.gov/dea/futures/deacbtlf.htm

Chicago Mercantile Exchange (Long Form) at
http://www.cftc.gov/dea/futures/deacmelf.htm

[jwh_Denver]

Supposedly the PPT manipulates the market by buying S&P 500 and DOW and NASDAQ futures when the market is dropping. Somehow, this supposedly forces the market back up. The problem is that buying futures cannot drive the stock market, which is obvious to real traders.

Every market day the indexes open in direct correlation to the futures. Also I believe what is missing here is the psychological effect that futures have on traders.

[Starwind]

Another great article, and informative comments. I'd appreciate constructive feedback on my thoughts.

I essentially agree with the premise that disguising a PPT and it's unlawful activity are major impediments for me to accept it's existence.

That said, I don't believe the article did justice to explaining away how the PPT might work. It claimed it doesn't exist but assumed a profit motive in any manipulation and then explained why profit-oriented manipulations were impractical.

So I'll play devil's advocate, and I have some questions. The anomalous behaviors I've seen which don't fit my admittedly limited understanding of how the big players trade are:

Frequent trades at and then above the ask price (they're not even trying to save money), widening of spreads, and volume trading inside the spread, then the bid moves up and the cycle repeats. Prices move up even when sellers outnumber buyers.

Huge staggered trades in DIA's, SPY's and QQQ's about 5-30 minutes apart, and seemingly synchronized trades in index weighted stocks noted above. I don't watch the entire market, just the indexes and options, the stocks noted (and other stocks I watch looking for an entry). At present I have no insight into option Time & Sales data, other than QQQ's and S&P minis are reported to have had a record breaking month. But I can't tie specific option trade volume to the forementioned index and stock movements.

There are no buyback plans announced for these stocks and Thompson I-Watch shows little or no retail interest in them, below average institutional interest, and the rest (non-I watch) of the volume has spiked (relative to monthly averages) on those days when it would seem the market reversed or rallied for no reason. There are no funds I know that would make concurrent trades in these diverse stocks and they are in different sectors.

The 'pattern' stops when the market moves upward and resumes when it falls off. IBM, GE, MMM, etc. are not the kind of stocks that would have huge short positions to be covered and this trading is not what an institution would do to unwind a position and I can see no reason (and I watch confirms) institutions are not accumulating positions.

These patterns are not observable when trading is heavy - too much chaos to detect any kind of signature, and a successful 'plunge protection' pattern doesn't work under heavy selling pressure.

I assume the hypothetical-PPT is not interested in profit or owning stocks. They are only interested in moving the price upward of everyone else's stock. Many of the arguments hinge on the intervener presumably ending up owning a bunch of stock to accomplish it's goal. I think that is a false assumption. I think they can move the price up and end with no position over a couple days if not hours. I elaborate below, but keep in mind how much hinges on a presumption of owning stock as opposed to trading stock.

And that often is what you see when there are large and strange moves. Just traders taking profit, either on the long side or short side. It is what Chris Fuligni calls his TFTF trade: Too Far Too Fast. When the market moves too much in one direction, traders take profits.

Consider this 3 month DJIA chart Jan 2003 to present:

The assumption is that the hypothetical-PPT reversed the most recent plunge on Mar 12, 2003, so I'd like to examine the various 'traders just taking profits' on that date.

Why would short positions be covered on a day the market was falling sharply? On such a day, what short trader would cover so as to reverse the market and force even more aggressive covering the next day? Who would have such a broad short position? Why would shorts preempt a profitable move down, just to take profits. If they had just gone short after Feb 21, would they not be interested in a larger move? If they had gone short back in January, they had already sustained at 300-400 point move up in mid-February and were at less risk on March 12 of needing to cover. Even if it is SOP for shorts to cover when the market makes big moves up (300-400 points), who initiated the move up? Who triggered the short covering?

Why would long positions be initiated or accumulated at a rate that drove the price up? If they wanted to accumulate why not do so at increasing lower prices? Isn't the long accumulation strategy to 'buy on the dips' and not reverse the dips? Who would accummulate such a broad position? What fund manager is that incompetent as to so drive up prices he has to pay? If a long position is being unwound, that adds to selling pressure and downward prices, not a reverse upward.

I would agree the following day, March 13th could have been short coverering which drove the prices up and then funds and others piled in and started a rally. But who had both the desire and ability to trigger the reversal the previous day? The reversal was not in a few key stocks, it was broad. What funds have such broad positions? I don't believe there are enough index tracking funds alone to produce the upward pressure. They'd have to be joined by other specialty/sector funds. I doubt they'd all coordinate well enough even if they desired to. I can't imagine any fund protecting a falling position by buying more stock - "never catch a falling knife" is another of Art Cashin's bits of wisdom.

Some would argue that the PPT does not lose money - that they are so good they buy the stocks and wait until the market goes back up before they sell.

Not necessary.

The hypothetical-PPT is only interested in driving up the price of everyone else's stock, they are not and need not be net long any stock to do that. They can buy out a seller at the ask, and the next at a higher ask, they can also buy above the ask, or become the seller and move the ask up. They can do this above the bid, encouraging bidders to likewise bid-up. As sellers see the ask come up, profit motive will induce them to raise it themselves. In this fashion the bid/ask and spread move up, though the hypothetical-PPT now owns some stock. When the spread has moved up enough and become wide enough, the hypothetical-PPT then sells back it's position inside the spread thereby unwinding itself without moving the price. The 'momentary' position (in any given stock) would have been small relative to the daily volume and easily sold back, especially if this is done every few upticks or so. This can be repeated throughout the trading hour, day or week. Net long positions and tens of billions of dollars are not needed.

Further, a hypothetical-PPT-trader can occupy the bid/ask position and trade with itself and thereby move the bid/ask up and widen the spread without any further net increase in shares owned by trading with itself. This can be done by having two or more hypothetical-PPT-front accounts and executing off-floor cross trades with itself. I'm uncertain how this is done in different exchanges but I'm told the rules/regs allow for company A to privately agree to trade with Company B via Broker X. This is a cross-trade between A and B and it is privately arranged via the broker off the floor. Once the trade is done, it hits the tape. There are rules about how quickly the result is reported, on the order of minutes.

Assume the foregoing is programmed trading with many hypothetical-PPT-front accounts and you have a system for manipulating stock prices, assuming you had the clout to set up the programs, accounts, and had an extendible slush fund to draw upon.

I would pick stocks that impact the COMP, DJIA and S&P 500 - like IBM, GE, MMM, JNJ, PG (and more) which overweight the DJIA and are in the S&P, and also MSFT, INTC which are in the COMP and DJIA, etc.

The problem is that buying futures cannot drive the stock market, which is obvious to real traders.

I have my doubts about how effective this is, especially on heavy selling days, but again, assuming a PPT and taking the rumors of a 'mystery options buyer' at face value, and assuming the hypothetical-PPT might try to make effective use of futures:

Buying futures cannot "drive" the stock market, but I believe it can nudge the market if it's otherwise drifting sideways and if the future buys are perceived by the writers as likely to be in the money. Depending on who is writing the options and how close to being in-the-money the option holder is, the writer (usually the broker) will either cover by buying stocks in the money and mitigate loss, or buy stocks and drive the price up out the money (if the option is a put), or short the stock and drive the price down out of the money if the option is a call. This is effective with thinly traded issues and seems less and less effective as more and more stocks are included.

Depending on the strike price for the preponderance of options written, proximity to the market price, and the writers exposure, this is what drives expiration trading crazy. Like with stocks, the hypothetical-PPT need not be a net holder of options. They can trade them away to someone else at a loss, or let them expire out of the money and take a loss on the premiums. Don't assume a profit motive.

Further, the hypothetical-PPT in fact is not always successful.

It may be most effective on light trading days to give and upward direction to a market that is trading sideways. Theoretically, they ought to anticipate good or bad news and try to move the market up before bad news (knowing a sell-off is pending and they won't be able to stop it but they can start it up higher so it ends higher) or move it up when good news is announced (to leverage the good news and start a rally or short covering).

This relies on greed and the anticipation of many traders that the 'bottom' is coming and the next bull run is not to be missed. Getting commentators to 'call the bottom' or 'distract attention to the war' would help as well. So many are looking for an excuse to pile in and up, and triggering a moderate move up is possible when there is not real selling pressure. Sellers are naturally inclined to raise prices provided the perception of a buyer is there. Bidder's not wanting to miss an upward move, are naturally inclined to follow - in absence of fundamentals - which is what makes this market bizarre.

The amounts of money required to attempt such a manipulation would be huge. We are talking tens of billions of dollars if there was a true collapse going on.

Only if a net position was being accumulated. As has been pointed out, the hypothetical-PPT can end up flat the market on a daily if not hourly basis. DOD black box projects frequently get billions allocated - stealth fighter development for instance. A hypotheical-PPT might be able to get what it needs, especially under Greenspan's Fed.

Also, in this regard, while I regard Art Cashin highly and found his explanation of arbitrage in indexes and futures contracts against indexes, etc interesting, Cashin did not directly address the issue of why trading futures would or would not move the market. Cashin only addressed the risk/profit motives for not attempting this, which in turn ignores a key premise of the hypothetical-PPT in that they don't care about the risk and aren't motivated by profit.

Furthermore, if there is a PPT, they are the most incompetent team in the world because the markets have indeed plunged.

Markets would have plunged further had not huge short positions covered. This is a truism. But must the catalyst have been short covering? Would not hypothetical-PPT intervention produce the same appearance, albeit a different cause? Do we assume short-covering only because we have no other answer?

By normal standards, a hypothetical-PPT is incompetent only because they made no profit and long-term the market will correct to align with economic fundamentals. The hypothetical-PPT's goal was to stave off a plunge - at which someone seems quite competent.

If my horse doesn't win - the race was fixed - the horse was doped. The variations are myriad. It can never be my fault or my miscalculation.

To the contrary, I don't hear anyone blaming a hypothetical-PPT for their losses (save possibly those who are long gold and blame shorters, though most of that blame I've read about is laid against the big banks and may be justified as I recollect reading the US government has yet to certify that it's gold reserves are actually in reserve and weren't loaned out to shorters). In fact folks on this thread and on this forum take a high degree of responsibility for their decisions, and are merely looking to avoid a rigged game. i.e. they want to avoid the irresponsiblity of government.

It was reported yesterday that money is flowing out of hedge funds and bear market funds because their profits have been wiped out in the recent bear market rallys. So who's left? Again, the hypothetical-PPT need not solely drive up the market, just trigger any previous or remaining shorts to cover is a good start, and also create enough perception in sellers and buyers that an incremental move up is possible, Greed will do the rest, if there is no fear or panic. Once reality sets in the hypothetical-PPT will not be able to stop it, as is evidenced by the many days of heavy selling and falling prices.

I would appreciate constructive criticism to educate me where I've misunderstood, or confirmation of possibilities and opinions as to likelihood.

Again, I doubt the PPT and I posted this not so much to persuade anyone the PPT is real, but to think out loud a bit about what is theoretically possible, and ask the question "If you were the PPT, how would you do it?"

[arete]

You are making this way too complicated.

Our whole economic system is connected to and dependent on stock pricing. Any meltdown or crash in the markets would collapse pension funds, banks, the credit bubble, insurance companies and everything else in the cross-wired paper asset IOU's backed by more paper asset IOU's. The result would be financial devestation which in turn would create tremendous political and social instability. There is no way with that risk sitting out there, that the ruling class elite in the political and financial markets are not going to be actively involved in "managing" the markets. It makes absolutely no difference how they do it nor will you ever pin them down to a single MO. You are talking about the FED, the Tresury Dept, and the Gang of 22. The biggest players on the planet have the means, resources and the methods and you will never find their finger prints on any of it. Just think about how easy it was for JPM to set up dozens of off balance sheet SPE's for Enron and shuffle enough money around to make even that sham look good for years while the crooks pocketed millions.

If it can be done -- and it can. If it needs done -- and it does. Market management and manipulation will take place.

Richard W.

[razorback-bert]

Well, I am glad to find out that the PPT is a fiction, invented by sore losers in a bar in the early hours of the morning.

[zechariah]

I assume the hypothetical-PPT is not interested in profit or owning stocks. They are only interested in moving the price upward of everyone else's stock. Many of the arguments hinge on the intervener presumably ending up owning a bunch of stock to accomplish it's goal. I think that is a false assumption. I think they can move the price up and end with no position over a couple days if not hours.
The hypothetical-PPT is only interested in driving up the price of everyone else's stock, they are not and need not be net long any stock to do that. They can buy out a seller at the ask, and the next at a higher ask, they can also buy above the ask, or become the seller and move the ask up. They can do this above the bid, encouraging bidders to likewise bid-up. As sellers see the ask come up, profit motive will induce them to raise it themselves. In this fashion the bid/ask and spread move up, though the hypothetical-PPT now owns some stock. When the spread has moved up enough and become wide enough, the hypothetical-PPT then sells back it's position inside the spread thereby unwinding itself without moving the price. The 'momentary' position (in any given stock) would have been small relative to the daily volume and easily sold back, especially if this is done every few upticks or so. This can be repeated throughout the trading hour, day or week. Net long positions and tens of billions of dollars are not needed.

I'm not clear on whether or not your scenario implies a net gain or loss on trades. If the PPT has moved the market up, but unloaded its position quickly, that seems to imply a profit. At most, it sounds like any net loss would be small. If tens of billions of dollars are not needed and, at most, losses would be small, then I think you have weakend your argument for PPT intervention--a rational, profit seeking market participant is more likely to be responsible. If the scenario you propose could be pulled off at a proft, then we simply have to assume that some player has figured out a new way to make a buck off the market. If the scenario involves a small loss, then I think it would be safest to assume that the loss is offset by some other position, eg, they move the market up in order to unwind a position or to load up on shorts or puts.

It may be most effective on light trading days to give and upward direction to a market that is trading sideways. Theoretically, they ought to anticipate good or bad news and try to move the market up before bad news (knowing a sell-off is pending and they won't be able to stop it but they can start it up higher so it ends higher) or move it up when good news is announced (to leverage the good news and start a rally or short covering).

Again, to me this makes a rational, profit seeking market player more plausible. Ie, it looks like someone is trying to "get some action going" when the market is otherwise quiet. Wouldn't the PPT want to do the opposite: quiet down a market that's gotten too jumpy?

As a further sanity check, how does your PPT-scenario match up against past, well known, large market plays? For instance, does anyone know the mechanics of Soros's play against the Bank of England back in the early 90's? He supposedly netted $1B. How long did the play take? How much capital did the play take? How much would he have lost had the play not worked out?

Inquiring minds want to know! ;)

[z]

[zechariah]

There is no way with that risk sitting out there, that the ruling class elite in the political and financial markets are not going to be actively involved in "managing" the markets.

It is not clear at all the the "ruling class elites" have any motive to prevent a downturn. True, I don't think that a sudden, massive crash is in their interests, but a slower, more drawn out downturn is nothing more than the final touches of a massive transfer of wealth and control into their hands.

[z]

[arete]

For them, it's a trade. They can't make nearly as much money with social unrest and political instability. They already paid good money for those politicians and they don't want to see them getting thrown out of office. Plus, they never know what the end result of social disorder may be. It is important that the serfs not become too restless, otherwise the puppet masters could literally lose their heads.

Richard W.

[Starwind]

I'm not clear on whether or not your scenario implies a net gain or loss on trades. If the PPT has moved the market up, but unloaded its position quickly, that seems to imply a profit.

But typically they are fighting a downward market, during which they take losses. Issues will move in different direction as well - profit in some, loss in others. Overall I would assume net losses, but less than if every share was bought and held all the way down. If the market reverses and recovers, I would assume they would unwind any position. For a profit-oriented trader sustained net losses, even if small, are to be avoided.

If the scenario you propose could be pulled off at a proft, then we simply have to assume that some player has figured out a new way to make a buck off the market.

Even when it might yield a profit, the cash required to trade sufficient volume (all the sellers that have to be taken out just to move the ask up) in all the issues to be moved is larger than any 'extra' cash a fund would have available. I haven't thought through if they'd try this on margin. In a downward market, I doubt a long-fund would risk it, and in a sideways market, I assume they'd wait or unwind. Obviously in an upward market there is no need.

Wouldn't the PPT want to do the opposite: quiet down a market that's gotten too jumpy?

I assume they're only trying to prevent a steep plunge or the 'cascading effect'. A sideways or upward 'jumpy' market they'd sit out.

Honestly, I'm outta my depth understanding how large trading is done and what attention it draws or not. I'm only trying to postulate a workable trading technique to move proces upward without regard to profit.

[Tauzero]

Great piece.

[AdamSelene235]

For instance, does anyone know the mechanics of Soros's play against the Bank of England back in the early 90's?

My understanding is that he triggered a run on the pound by selling it short in large quantities.

He supposedly netted $1B. How long did the play take?

< 24 hours

How much capital did the play take?

$10 billion

How much would he have lost had the play not worked out?

10 billion X the percent the pound increased in value.

Do a google on ERM & Soros for more background on the unusual exchange rate circumstances surrounding the trade.

[OwenKellogg]

In case you think this is timely...