Originally Published NOVEMBER 30, 2019
On October.16th, Cronos Group shocked the market by suddenly spiking as much as 40% in the after-hours. This occurred on no news whatsoever.
Before the open, everybody naturally expected some kind of mega announcement. Surely if the price were to go up that much, and on such heavy volume, it would warrant something, right? But nothing came, and as the weeks drew on, it was beginning to look like nothing was going to come. Apparently this 40% move was just a random event.
What could possibly be responsible for this $1.5 billion spike in Cronos Groups market cap? Was there a glitch somewhere? Is there something us mere mortals are missing? Did the HFT’s move with such spontaneous fervor that it caused some kind of quantum event — spooky action at a distance?
To the unlucky investors that were unfortunate enough to get sucked into this pump and dump, it was only a matter of time before something was bound to happen. There is no way a stock can go up that much on such heavy volume without something, anything, happening.
Well, last week, something did, after all this time, finally happen: the entire sector tanked. Many of the marijuana giants, like Canopy and Aurora, reported abysmal earnings, resulting in a heavy sell off that wiped away billions of dollars in market cap. Cronos Group was also one of these companies, so it makes you wonder: did somebody know this was going to happen ahead of time, and more importantly, was that order in the after-hours actually a sell, and not a buy?
Smart money is known to be privy to information before the rest of the population, whether that be through privileged connections, or access to paid research, so some might speculate that this massive order was somebody unloading their position before the news dropped.
But it seems unlikely that insider trading would be responsible for this unusual price action. Anybody who closely followed the sector at that point would have known that things were not looking very good, so even if this order was in fact a sale, it was probably just a large investor taking protective action ahead of what was likely to be a tough earnings session. This is why we should be looking at who actually executed this sell order, rather than who made the sale.
Most large after-hours orders are executed by what are known as dark-pools. These trading venues are for the most part utilized by fund managers who wish to execute large block trades without upsetting the market. The NYSE provides a good description of dark pools on their website.
“When traders need to trade a large block of a given stock, they often trade off-exchange to avoid causing price disruptions. In the past, off-exchange trading was usually done between two brokers over the phone, in a legal practice called ‘upstairs trading’. As technology and regulations changed, large institutional broker-dealers created their own ‘alternative trading systems’ or ‘dark pools’ to conduct these trades. In dark pool trading, the prices at which parties are willing to trade are not visible. Dark pools and dark trading is legal, but dark pools are not subject to the same rigorous regulations as licensed exchanges.
The ability to trade in the dark has its role in efficient equity markets, however transparent, public trading venues where participants can see the prices is critical to the price discovery process. For this reason, NYSE continues to promote displayed markets and to prioritize lit (versus dark) trading activity”. Link
The Securities Industry and Financial Markets Association (SIFMA) describes these order executions as complex, saying that if they are not executed properly, they can significantly move markets
Have you ever heard of a “married-put”? It’s okay if you haven’t, they are very simple to understand. They might sound complicated, but the concept is very simple once you get past all the industry lingo, and it could be the key to understanding what happened to Cronos Group in the after-hours on October.16th.
When an investor purchases stock, they will sometimes hedge their bets by purchasing an equal amount of put options which boxes them in from any declines in the share price. For example, if you bought 100 shares of Apple, in a married put transaction, you would also buy an option equal to 100 shares of Apple which would be exercisible at the same price you purchased your stock.
For example, if you were to buy Apple for $200, in married transaction, you would also buy puts that would also be exercisible at $200. In layman’s terms, it’s basically just an agreement where you buy stock from somebody who also allows you to sell it back to them at the same price.
These transactions have been shown to occur frequently in the microcap sector during secondary offerings. Since investors are not allowed to short sell five days before an offering, they will sometimes attempt to mimic a short sale by first purchasing the stock, then buying a married put and immediately dumping the stock they originally purchased. They do this with the intention of first buying it back once the price has collapsed, then re-selling it to whoever sold them the put option, thus booking a profit. You can read about it in further detail here (if you have any questions, just leave a comment)
If you had trouble understanding that last part, that’s okay, because it’s not necessary for you to understand what happened with Cronos Group. Pictured below is a simplified illustration of how this could work.
But who is this other person buying all that stock at $12.00 you might be wondering? The price closed at $8.30, so why would anybody buy all that stock at such an outrageously inflated price? Remember, there was no news — not the next day, not the next week, not even the next month. If this was just a regular investor, they wouldn’t be feeling all that great right now considering where the price is sitting today.
The answer to this question could be in the Pipeline LLC controversy.
In 2011, Pipeline Trading Systems, an alternative trading system (darkpool), was charged with front running their customers. It came out in the investigation that they were utilizing a secret trading affiliate that was executing most of their customers orders, and Pipeline’s customers were completely unaware of this, thinking the whole time that they were trading among themselves.
This was because Pipeline marketed itself as a trading venue where large institutional investors could execute their orders in private without worrying that they would be taken advantage of by electronic trading algorithms that had the ability to predict and trade ahead of their orders, and in effect, steal their investors money.
Because Pipeline wanted to create the impression that their trading venue was a liquid market place, they created a subsidiary that would buy and sell stock on the main stock exchanges, and unbeknownst to their customers, become the primary source of liquidity on Pipelines darkpool.
The reason why Pipeline kept this a secret was because these institutional investors wanted to trade with each other, and not with some opaque third party that could potentially front run their orders. If they wanted to trade with an HFT, they could have easily done so on the NASDAQ or NYSE, which was why they were seeking to trade on an alternative system in the first place
Without the affiliate, a fully liquid marketplace, like what is seen on the NASDAQ and NYSE, would be impossible. There was simply not enough buyers and sellers.
You begin to see that this “affiliate” was essentially just fabricating a liquid marketplace that would’ve otherwise not existed without its trading activities. No customers were buying and selling among each other, and without the NYSE and NASDAQ, Pipeline, by all intensive purposes, would have struggled to even exist.
Here is the key. It was also revealed that during the majority of this affiliates tenure, it was actually losing money, which clearly displays how important maintaining a liquid trading environment was to Pipeline. For them, these losses were just the cost of doing business, and as long as customers orders were being filled on a timely basis, it didn’t matter if they lost a little of bit of money in the process. They even designed an incentive plan that attempted to lessen the impact of this affiliates conflict of interest.
As you can see, the trading losses incurred by the affiliate exceeded the profits.
From analyzing this litigation release, we learn three key facts
1. Darkpools have trading affiliates that locate stock outside of their trading venue because it would be impossible to maintain an environment that is liquid enough to attract institutional investors
2. The trading mechanism (the affiliate) that is utilized to fabricate this false sense of liquidity is prepared to take a loss as a cost of doing business
3. Some dark pools cannot operate without locating stock on a normal public exchange, like the NYSE or NASDAQ
It is also interesting to note that the midpoint between the high and the low closely lines up with where the price opened on the following day.
This is all just speculation of course because unfortunately we don’t have access to any specific data. What we do know is that it seems very suspicious for a company’s market cap to spontaneously increase by $1.5 billion on absolutely no news whatsoever, then follow up with a 50% decline only 4 weeks later. The volume on October. 17th was also abnormally high compared to the average during that general time frame, which suggests that there were many investors that could have been sucked into buying at these artificially inflated prices.
If you would like to learn more about market manipulation, check out the article below.
Until the next time everyone