Subject: Exchanges - Circuit Breakers, Curbs, and Other Trading Restrictions

Last-Revised: 4 June 2007
Contributed-By: Chedley A. Aouriri, Darin Okuyama, Chris Lott (contact me), Charles Eglinton

A variety of mechanisms are in place on the U.S. exchanges to restrict program trading (i.e., to cut off the big boy's computer connections) whenever the market moves up or down by more than a large number of points in a trading day. Most are triggered by moves down, although some are triggered by moves up as well.

The idea is that these curbs on trading, also known as collars, will limit the daily damage by restricting activities that might lead towards greater volatility and large price moves, and encouraging trading activities that tend to stabilize prices. Although these trading restrictions are commonly known as circuit breakers, that term actually refers to just one specific restriction.

These changes were enacted in 1989 because program trading was blamed for the fast crash of 1987. Note that the NYSE defines a Program Trade as a basket of 15 or more stocks from the Standard & Poor's 500 Index, or a basket of stocks from the Standard & Poor's 500 Index valued at $1 million or more.

Trading restrictions affect trading on the New York Stock Exchange (NYSE) and the Chicago Mercantile Exchange (CME) where S&P 500 futures contracts are traded. When these restrictions are triggered, you may hear the phrase "curbs in" if you listen to CNBC.

Here's a table that summarizes the trading restrictions in place on the NYSE and CME as of this writing. The range is always checked in reference to the previous close. E.g., a move of up 200 and down 180 points would still be an up of 20 with respect to the previous close, so the first restriction listed below would not be triggered. Any curb still in effect at the close of trading is removed after the close; i.e., every trading day starts without curbs.

Note that the "sidecar" rules were eliminated on Tuesday, February 16, 1999.

Now some details about each.

NYSE Collar (Rule 80A): Index arbitrage tick test

Rule 80A provides that index arbitrage orders can only be executed on plus or minus ticks depending on the change in the NYSE Composite Index (NYA). In the parlance of the NYSE, the orders must be "stabilizing." This rule only effects S&P 500 stocks, and is also known as the "uptick downtick rule" because it restricts sells to upticks and buys to downticks. In other words, when the market is down (last tick was down), sell orders can't be executed at lower prices. In an up market (last tick was up), buy orders can't be executed for higher prices. This collar is removed when the NYA retraces its gain or loss to within approximately 1% of the previous close. As of mid 2007, the collar is imposed at a 2% movement in the NYA based on the previous close, which means a 180 point change triggers the collar, and a move back within 90 points removes the collar. In October 2005 the exchange switched from using the DJIA to the NYA.

CME Restrictions

Trading in the S&P500 futures contract is halted just for a few minutes if the prices moves 2.5%, 5%, or 10% from the previous close. Because restrictions on the NYSE effectively shut down trading in this futures contract, there is little need for additional restrictions on the CME.

NYSE Circuit Breakers

These restrictions are also known as "Rule 80B." The first version of this rule, adopted in 1988, set triggers at 250 DJIA points and 400 DJIA points. These restrictions are updated quarterly to reflect the heights to which the Dow Jones Industrial Average has climbed.

• 10% decline (950 points for 3Q02)
  The first circuit breaker is triggered if the DJIA declines by approximately 10%. The restrictions that are put into place -- if any -- depend on the time of day when the circuit breaker is triggered. If the trigger occurs before 2pm Eastern time, trading is halted for 1 hour. If the trigger occurs between 2 and 2:30pm Eastern, trading is halted for 30 minutes. If the trigger occurs after 2:30pm Eastern time, no restrictions are put into place. (This restriction was first used during the afternoon of 27 Oct 97.) Note that there is no similar restriction to the upside; nothing is done if the Dow rallies 10%.

• 20% decline (1900 DJIA points for 3Q02)
  The second circuit breaker is triggered if the DJIA declines by approximately 20%. The restrictions that are put into place again depend on the time of day when the circuit breaker is triggered. If the trigger occurs before 1pm Eastern time, trading is halted for 2 hours. If the trigger occurs between 1 and 2pm Eastern, trading is halted for 1 hour. If the trigger occurs after 2pm Eastern time, the NYSE ends trading for the day. Again there is no similar restriction to the upside; nothing is done if the Dow rallies 20%.

• 30% decline (2850 DJIA points for 3Q02)
  The third circuit breaker is triggered if the DJIA declines by approximately 30%. The restriction is very simple: the NYSE closes early that day. And like the other cases, again no restrictions are imposed if the Dow rallies 30%.

The circuit breakers cut off the automated program trading initiated by the big brokerage houses. The big boys have their computers directly connected to the trading floor on the stock exchanges, and hence can program their computers to place direct huge buy/sell orders that are executed in a blink. This automated connection allows them to short-cut the individual investors who must go thru the brokers and the specialists on the stock exchange.

Statistical evidence suggests that about 2/3 of the Mar-Apr 1994 down slide was caused by the program traders trying to lock in their profits before all hell broke loose. The volume of their trades and their very action may have accelerated the slide. The new game in town is how to outfox the circuit breakers and buy or sell quickly before the 50-point move triggers the halting of the automated trading and shuts off the computer.

Here are sources with more information:

• HL Camp & Company offers a concise summary of program trading collars including current numbers on their web site.
  http://www.programtrading.com/curbs.htm
• The Chicago Mercantile Exchange publishes their equity index price limits.
  http://www.cme.com/products/index/products_index_pricelimitguide.cfm
• The NYSE publishes press releases every quarter with the numbers for that quarter's circuit breakers.
  http://www.nyse.com/press/circuit_breakers.html
• The NYSE's glossary includes definitions of the term "Circuit Breakers".
  http://www.nyse.com/help/glossary.html

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