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Anatomy of the Circuit Breaker

March 12th | 2020





We dusted off the circuit breaker rules this week, first implemented in 1987 and altered with limit up/limit down rulemaking in 2010. This week’s triggering of the circuit breakers was only the second time the mechanism had been triggered since its implementation.

Because these rules are not part of our everyday trading world, they are worth a review. Please find a summary below:


The Limit Up/Limit Down plan (LULD) in U.S. equities markets that was implemented after 2010’s flash crash. These measures are intended to dampen volatility where there are sudden declines market wide or on a single stock basis.


A market-wide decline means a decline in price of the S&P 500 Index between 9:30 a.m. EST and 4:00 p.m. EST on a trading day as compared to the closing price of the S&P 500 Index for the immediately preceding trading day. Trading will be halted market wide depending on the severity of the decline as follows:


There are also security specific LULD price bands. A security will enter a “Limit State” when the National Best Offer (NBO) equals the Lower Price Band or when the National Best Bid (NBB) equals the Upper Price Band. If a security remains in a Limit State for 15 seconds the security will enter a five-minute trading pause and then re-open with an auction at the primary listing exchange for the security. Securities are grouped into two tiers with varying percentages required to enter a Limit State as shown below.

Tier 1 securities include all securities in the S&P 500 or Russell 1000 Index and all ETPs defined in the LULD Tier 1 ETP List.

Tier 2 encompasses all other securities that are not in Tier 1. Warrants and rights do not have any LULD bands.

Note that prior to February 24, 2020, LULD Price Bands were calculated by applying double the percentage parameters just after the open and before the close (e.g., 9:30 a.m. to 9:45 a.m; 3:35 p.m. and 4:00 p.m. ET).


A recent LULD amendment, however, eliminated the doubling of percentage parameters just before the open for all securities; and just before the close for Tier 2 securities with a reference price above $3.00. Tier 1 securities and Tier 2 securities with a reference price at or below $3.00 will continue to apply double percentage parameters between 3:35 p.m. and 4:00 p.m. ET.


Short Sales


In addition to the LULD plan, SEC Reg. SHO Rule 201 contains a circuit breaker that, when triggered, restricts the prices at which securities can be sold short. The trigger is where a covered security decreases by 10% or more from its prior closing price; if that happens, short sales may only be displayed or executed on an uptick. There is an exception for orders that brokers determine to mark “sell short exempt”.


Derivatives


The CFTC has worked with the SEC on measures to address volatility concerns regarding security futures, which fall under the jurisdiction of both agencies. These rules and the rules developed by futures and options exchanges generally halt trading of derivatives when the underlying(s) are halted. In fact, CME Group U.S. equity index price limits (and corresponding CME and CBOT rules) are designed to coordinate with circuit breakers provisions as applied by the New York Stock Exchange. Accordingly, the baseline circuit breaker percentages for equity index products are like the LULD limits described above (7%, 13%, and 20% from 9:30 a.m. to 3:25 p.m. ET, and 20% 3:25 p.m. to 4:00 p.m. ET). CME publishes the percentages applicable to all its products daily.

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