Last Thursday's incredible market plunge may not have been set off by a typographical error, as originally speculated, but rather by a hedge fund's big bet that stocks would decline, according to a Wall Street Journal report ($) Tuesday.
The furious sell-off, which sent the Dow Jones industrials down nearly 1,000 points on the day in a matter of minutes, took place shortly after hedge fund Universa Investments LP executed a $7.5 million trade for 50,000 options contracts, according to the report. Traders on the other side of the transaction, including Barclays Capital, engaged in their own selling in order to offset the risk, creating a tidal wave of selling that clogged up exchanges.
Ordinarily, Universa's trade, which would have paid off around $4 billion if the S&P 500 falls to 800 by June (it was 1145 at the time of the transaction), might have had a temporary impact on stock prices, but not cause a dramatic ripple effect. But among markets already jittery because of Europe's debt woes, the transaction may have triggered more widespread selling, according to the report.
The episode points out a "structural flaw" in the markets, Gus Sauter, chief investment officer at Vanguard Group, told the Journal.
As the report notes, physical exchanges like the New York Stock Exchange are becoming less important as computer-driven trading operations at firms around the country drive much of the market. That leads to greater potential for disorder and makes controlling markets more difficult.