Published August 08, 2012
Knight Capital can’t seem to catch a break.
A day before the firm’s massive computerized trading error, a Knight (KCG) trader on the floor of the New York Stock Exchange flubbed an order for the stock Ensco PLC (ESV) that cost Knight nearly $1 million, people with knowledge of the matter say.
The NYSE loss was nowhere near the $440 million algorithm glitch that has crushed shares and forced Knight to find new investors. But people close to the firm say it’s still significant: It may wipe out the year’s profits of Knight’s NYSE “specialist” unit and, given the firm’s post-error financial condition, could imperil its NYSE trading division, one of the few remaining on the floor of the Big Board.
One of the problems with even such a relatively small loss is that it is still nearly half of Knight’s “value at risk” or VAR, a measurement of how much the firm expects to lose in any given trading day.
Knight tells analysts that, given its risk controls, it doesn’t expect to lose more than $2.2 million, making the NYSE trading loss almost half its VAR and raising additional questions about the firm’s risk controls.
A spokeswoman for Knight would not deny the NYSE loss, but said that for now, the firm has no plans to shutter its specialist unit.
Specialists are traders on the floor of the exchange who match buyers and sellers of stock. They have been diminishing in numbers in recent years as the NYSE has offered investors a new electronic market making system.
One problem for the traders is that one of Knight’s new investors, Getco, also a trading firm, has its own unit, meaning the two teams could be consolidated at some point. Knight has about 20 people on the NYSE floor.
One additional reason to combine the units would be Knight’s lack of profitability. Even before the NYSE loss, Knight’s unit was profitable but pulled just $1 million and $2 million a year, according to people with knowledge of the matter. A Knight spokeswoman did not deny those numbers.
At the same time, Knight must dedicate millions of dollars in capital so its specialists can trade, making any loss significant given the size of the business.
The problem for Knight began when traders sought to profit on shares Ensco, an offshore drilling company, early last week due to rebalancing of one of the Standard & Poor’s indexes. So-called rebalancing usually leads to an initial spike in the price of stocks, and then a decline in their value.
That’s what happened with Ensco; shares began to rise on Monday Aug. 30 to $56.22 but then fell nearly 4% the next day. The problem for Knight involved what floor traders are calling a “miscommunication” with another trading shop over how much Ensco Knight thought it had purchased.
When the firm realized it was still holding shares of Ensco on Tuesday, Aug. 31 when the shares fell $2.11, it had to split its loss with the other firm, taking an $800,000 hit.