ELECTRONIC TRADING STRATEGIES

Street Color
Is su e 6 Un ited St at es | F eb ru ar y 2 4 , 2 010

FOCUS ARTICLE: SHORT SALE PRICE TESTS

Kilian Mie
kilian.mie@gs.com
NY: 917-343-8529
Ingrid Tierens
ingrid.tierens@gs.com
NY: 212-357-4410
Goldman Sachs Electronic
Trading Strategies
This material has been
prepared by Goldman Sachs
Electronic Trading Strategies
and is not a product of
Global Investment Research
or Fixed Income Research.
Important disclosures
appear at the end of this
material.
The Securities and Exchange Commission will announce its decision on amendments to
Regulation SHO on Wednesday, February 24, 2010. One of the proposals the
Commission has been considering is a “circuit breaker” for securities during severe
price declines. We provide historical analysis on the frequency of such a scenario
assuming that a severe price decline is defined as a drop in the stock price of at least 10%
compared to the previous day’s close.
 From January 2008 until February 2010, about 2% of the current S&P 500
constituents hit the -10% price test. This translates into 11 S&P 500 names
per average trading day. The corresponding numbers for the current Russell
2000 universe are 4% of the index, or 79 names per average trading day.
 The number of price declines fluctuated significantly during the past two
years. In October 2008, 15% of the current S&P 500 index (74 names per
average trading day) would have been impacted by the price test, while year-to-
date only 0.2% (one name per average trading day) hit the -10% limit.
 Weighting the results by traded volume to account for liquidity differences across
securities, we find that on average 3.2% (6.3%) of the dollar volume traded for
the current S&P 500 (Russell 2000) constituents would have hit the -10%
price limit from January 2008 until February 2010.
Number of stocks per average trading day dropping by at least 10% intraday
S&P 500 Russell 2000
400
Number of stocks per average trading day

350

300

250

200

150

100

50

0
Nov-08

Nov-09
Jan-08

Jun-08
Jul-08

Jan-09

Jun-09
Jul-09

Jan-10
Feb-08
Mar-08
Apr-08
May-08

Aug-08
Sep-08
Oct-08

Dec-08

Feb-09
Mar-09
Apr-09
May-09

Aug-09
Sep-09
Oct-09

Dec-09

Feb-10

Source: Bloomberg, Russell, Standard & Poor’s, Goldman Sachs Electronic Trading Strategies

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 1

 

FOCUS ARTICLE: SHORT SALE PRICE TESTS

The Securities and Exchange Commission will announce its decision on amendments to
Regulation SHO on Wednesday, February 24, 2010. One of the proposals the
Commission has been considering is a “circuit breaker” for securities during severe
price declines, with short selling for securities that meet the circuit breaker price test only
allowed at a price above the current national best bid.

We assume in this article that a severe price decline is defined as a drop in a security’s
price of at least 10% compared to the previous day’s close, and we analyze how often
these price declines occurred since the start of 2008 for the current constituents of the
S&P 500 index and the Russell 2000 index.

More specifically, for each constituent of the S&P 500 and Russell 2000, we calculate a
daily “low return” defined as the percentage return of the stock’s low during the trading day
compared to the previous day’s close. If this “low return” is -10% or worse, the stock is
flagged as a circuit breaker candidate. Exhibit 1 summarizes the frequency of these circuit
breaker events for the entire sample period from January 1, 2008 until February 22, 2010.
With 539 distinct trading days and 500 (1996) current constituents in the S&P 500 (Russell
2000), we have 269,500 (1,075,844) potential daily circuit breaker events in the S&P 500
(Russell 2000) universe. The S&P 500 constituents experienced daily price declines of
10% or more 5,731 times over the past 26 months, while the Russell 2000 constituents
recorded more than 42,000 such events. In other words, 2.1% of the current S&P 500
constituents hit the -10% circuit breaker since January 2008, which translates into
about 11 S&P 500 names per average trading day. The corresponding numbers for
the current Russell 2000 universe are 3.9% of the index, or 79 names per average
trading day.

Exhibit 1: Frequency of daily “low returns” of -10% or worse (Jan 2008 – Feb 2010)
S&P 500 Russell 2000
-10% circuit breaker events 5,731 42,426
Trading day / stock combinations 269,500 1,075,844
Proportion of index universe 2.1% 3.9%
Number of stocks per average trading day 10.6 78.7
Source: Bloomberg, Russell, Standard & Poor’s, Goldman Sachs Electronic Trading Strategies

The overall summary does however mask significant variation throughout the sample
period. Exhibit 2, which shows the analysis on a monthly basis, underscores how the
market turmoil during the fall of 2008 and the subsequent overall market decline during the
first quarter of 2009 tilted the numbers. In October 2008, the proportion of all possible
combinations of trading days and current Russell 2000 constituents flagged as “-10%
circuit breaker” events jumped to almost 15% for the current S&P 500 universe and 18%
for the current Russell 2000 universe. On average, more than 70 S&P 500 names and
more than 350 Russell 2000 names hit the trigger each trading day of that month. During
the past two months on the other hand, only 0.2% of the S&P 500 index (about one
stock per average trading day), and less than 1% of the Russell 2000 index (slightly
more than 10 stocks per average trading day) experienced “low returns” of -10% or
less.

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 2

  

Number of stocks per average trading day Proportion of current index universe

0
50
100
150
200
250
300
350
400
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%

Jan-08 Jan-08
Feb-08 Feb-08
Mar-08 Mar-08
Apr-08 Apr-08
May-08 May-08
Jun-08 Jun-08
Jul-08 Jul-08
Aug-08 Aug-08
Sep-08 Sep-08
Oct-08 Oct-08
Nov-08 Nov-08
Dec-08 Dec-08
S&P 500
S&P 500

Jan-09 Jan-09
Feb-09 Feb-09
Mar-09 Mar-09
Apr-09 Apr-09
May-09 May-09
Russell 2000
Russell 2000

Jun-09 Jun-09
Jul-09 Jul-09
A. Proportion of current index universe

Aug-09 Aug-09

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR

Sep-09 Sep-09
B. Number of stocks per average trading day

Oct-09 Oct-09
Nov-09 Nov-09
Dec-09 Dec-09
Jan-10 Jan-10
Feb-10 Feb-10
Exhibit 2: Monthly frequency of -10% or worse “low returns” (Jan 2008 – Feb 2010)

3
 

Proportion of current index Number of stocks per

universe average trading day
S&P 500 Russell 2000 S&P 500 Russell 2000
Jan-08 1.0% 2.8% 4.9 56.0
Feb-08 0.2% 1.3% 1.2 26.0
Mar-08 0.6% 2.1% 2.8 41.8
Apr-08 0.2% 1.2% 1.2 24.6
May-08 0.1% 1.1% 0.6 21.5
Jun-08 0.3% 1.3% 1.6 26.7
Jul-08 1.4% 2.7% 6.8 54.7
Aug-08 0.4% 1.7% 2.2 33.9
Sep-08 4.7% 6.0% 23.5 120.2
Oct-08 14.7% 18.0% 73.6 358.6
Nov-08 8.9% 14.6% 44.6 292.0
Dec-08 4.5% 10.1% 22.7 202.4
Jan-09 3.7% 7.4% 18.3 147.3
Feb-09 4.0% 6.8% 19.8 135.0
Mar-09 4.1% 8.4% 20.5 167.8
Apr-09 2.1% 4.2% 10.4 84.3
May-09 1.5% 3.8% 7.3 76.8
Jun-09 0.4% 2.7% 2.1 53.0
Jul-09 0.5% 1.6% 2.5 32.1
Aug-09 0.1% 1.4% 0.7 27.3
Sep-09 0.1% 0.7% 0.6 14.8
Oct-09 0.2% 1.5% 1.1 30.6
Nov-09 0.2% 1.0% 0.8 19.9
Dec-09 0.1% 0.4% 0.3 7.3
Jan-10 0.2% 0.6% 0.9 11.3
Feb-10 0.2% 0.7% 1.2 14.8

Source: Bloomberg, Russell, Standard & Poor’s, Goldman Sachs Electronic Trading Strategies

Less liquid, more volatile names are expected to be more affected by the circuit
breaker proposal. While the previous analysis treated all stocks equally, Exhibit 3 tries to
account for liquidity differences by weighting each circuit breaker event by the composite
dollar volume traded for each affected stock on the day it hit the -10% limit. For each
month in our sample, we sum the dollar volume of all impacted stocks and divide it by the
total dollar volume traded for all constituents in its index universe.
Exhibit 3: Volume-weighted frequency of -10% trigger events (Jan 2008 – Feb 2010)

S&P 500 Russell 2000

25%
21.8%

20%
Proportion of $ volume traded

15.8%

15%

10%
7.5%

5% 3.7%
3.3% 0.6%

0%
Nov-08

Nov-09
Jan-08

Jun-08
Jul-08

Jan-09

Jun-09
Jul-09

Jan-10
Feb-08
Mar-08
Apr-08
May-08

Aug-08
Sep-08
Oct-08

Dec-08

Feb-09
Mar-09
Apr-09
May-09

Aug-09
Sep-09
Oct-09

Dec-09

Feb-10

Source: Bloomberg, Russell, Standard & Poor’s, Goldman Sachs Electronic Trading Strategies

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 4

 

On average, 3.2% of the $ traded volume for the current S&P 500 constituents was
impacted by the -10% price test since January 2008. The number was almost twice
as large for the current Russell 2000 universe (6.3%). Again, the averages are driven
by extreme numbers (15.8% for the S&P 500 and 21.8% for the Russell 2000) observed
during October 2008. Month-to-date as of February 22, 2010, only 0.6% of the S&P 500
traded volume and 3.7% of the Russell 2000 traded volume belonged to stocks that hit the
trigger level.

Exhibit 4: Volume-weighted frequency of -10% trigger events by sector (Jan 2008 –

Feb 2010)

S&P 500 Russell 2000

10%
8.7%
Proportion of $ volume traded

9%
8% 7.3%
7.0%
6.7% 6.3% 6.6%
7% 6.3%
5.8%
6% 5.3%
5% 4.6% 4.6%

4% 3.5%
3.0%
3% 2.4%
1.9% 1.9% 1.9% 1.8%
2% 1.4%
1.0%
1%
0%

Industrials
Energy

Utilities
Discretionary

Consumer Staples

Financials

Technology
Information

Materials

Telecommunication
Health Care
Consumer

Services
Source: Bloomberg, Russell, Standard & Poor’s, Goldman Sachs Electronic Trading Strategies

Exhibit 4 slices the traded volume analysis by sector. Not surprisingly, financials
dominated the S&P 500 price test events with 7.3% of the sector’s dollar volume
traded impacted by the test. In the small-cap universe, the utilities sector was a
noticeable outlier with only 1.4% of its dollar traded volume affected.

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 5

  

TRENDS IN ESTIMATED SHORTFALL, BID-ASK SPREADS, VOLUME AND VOLATILITY

 

 Estimated shortfall
showed an uptick in
February 2010.

 Similarly, quoted half-

spreads increased for
S&P 500, and hardly
changed for Russell
2000.

 Month-to-date dollar
volumes are comparable
to January.

 Volatility measured over

21-day rolling windows
declined until the
beginning of the year and
moved upward in
February 2010.

 
Source: Bloomberg, Reuters, Russell, Standard & Poor’s, Goldman Sachs

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 6

  

SECTOR ANALYSIS FOR CORRELATIONS, BID-ASK SPREADS AND VOLATILITY

 

 For most sectors,

correlation levels
across stocks
increased, in particular,
for the S&P 500.

 Quoted half-spreads
are generally lower
compared to levels
experienced over the
past six months.

 For the S&P 500 index,

the uptick in volatility at
the index level is
mirrored at the sector
level, with the exception
of the Telecoms sector.

 
Source: Bloomberg, MSCI GICS, Reuters, Russell, Standard & Poor’s, Goldman Sachs 

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 7

 

APPENDIX
Expected shortfall
This number relies on the Goldman Sachs Shortfall Model (GSSM) and assumes trading a $500 mn
portfolio over a full trading day. The order size for each of the stocks in the corresponding index
(S&P 500 or Russell 2000) equals the index weights times the size of the portfolio ($500 mn). We
use the GSSM to generate the expected shortfall (all-day executions) for each of the index
constituents in bps and calculate a weighted average of these individual expected shortfall numbers,
using the index weights. We calculate this number for each trading day during the month. The
candle sticks in the plot display the median expected shortfall (in bps) during the month, as well as
the minimum, maximum, 10th percentile and 90th percentile.
Quoted half-spread
We compute the market cap weighted average quoted half-spread (half of the bid-ask spread) across
the stocks in the corresponding index (S&P 500 or Russell 2000) for each trading day during the
month. The candle sticks in the plot display the median of the weighted average quoted half-spread
(in bps) during the month, as well as the minimum, maximum, 10th percentile and 90th percentile.
Quoted half-spreads for sectors
We compute the market cap weighted average quoted half-spread (half of the bid-ask spread) across
the stocks in the corresponding GICS sector in the corresponding index (S&P 500 or Russell 2000)
for each trading day during the past 6 months. The candle sticks in the plot display the median of the
weighted average quoted half-spread (in bps) during the past half year, as well as the minimum,
maximum, 10th percentile and 90th percentile for each sector and for the overall index. In addition,
the blue square marks the most recent weighted average quoted half-spread.
Stock correlations within sectors
For each stock within the corresponding GICS sector in the corresponding index (S&P 500 or Russell
2000), we calculate its volatility over a rolling 21-day window using daily returns. We similarly
calculate the volatility of the sector returns over the same time horizon. It can be shown that the
average stock correlation within the sector can be proxied by the ratio of
 the sector variance (the square of the sector volatility) minus the weighted sum of the
variance of each stock in the sector, where the weights are the squares of the market
capitalization weights of each stock within the sector, and

 the sum of each pairwise product of a stock’s volatility with another stock’s volatility, each
weighted by their market capitalization weight in the sector.
The candle sticks in the plot display the median correlation during the past 6 months, as well as the
minimum, maximum, 10th percentile and 90th percentile for each sector. In addition, the blue square
marks the most recent stock correlation.
Volatility
We calculate the standard deviation of the daily returns for the corresponding index (S&P 500 or
Russell 2000) over a rolling 21-day window for each trading day during the month. The candle sticks
in the plot display the median volatility (in annualized percentage) during the month, as well as the
minimum, maximum, 10th percentile and 90th percentile.
Volatility for sectors
We calculate the standard deviation of the daily returns for the corresponding GICS sector in the
corresponding index (S&P 500 or Russell 2000) over a rolling 21-day window for each trading day
during the past 6 months. The candle sticks in the plot display the median volatility (in annualized
percentage) during the past 6 months, as well as the minimum, maximum, 10th percentile and 90th
percentile. In addition, the blue square marks the most recent sector volatility.
Volume
We sum the dollar volume across the stocks in the corresponding index (S&P 500 or Russell 2000)
for each trading day during the month. The candle sticks in the plot display the median volume (in
$mn) during the month, as well as the minimum, maximum, 10th percentile and 90th percentile.

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 8

 

Copyright 2010. The Goldman Sachs Group, Inc. All rights reserved.

This material has been prepared by personnel in the Equity Execution Strategies Group within the
Equities Division and is not the product of Global Investment Research or Fixed Income Research. It is
not a research report and is not intended as such.

Non-Reliance and Risk Disclosure: This material should not be construed as an offer to sell or the solicitation of
an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. We are not
soliciting any action based on this material. It is for the general information of our clients. It does not constitute a
recommendation or take into account the particular investment objectives, financial conditions, or needs of
individual clients. Before acting on any advice or recommendation in this material, you should consider whether it
is suitable for your particular circumstances and, if necessary, seek professional advice. Certain transactions -
including those involving futures, options, equity swaps, and other derivatives as well as non-investment-grade
securities, foreign-denominated securities and securities, such as ADRs, whose value is influenced by foreign
currencies - give rise to substantial risk and may not be available to or suitable for all investors. This material is
not for distribution to private customers, as that term is defined under the rules of the Financial Services Authority
in the United Kingdom; and any investments, including derivatives, mentioned in this material will not be made
available by us to any such private customer. The material is based on information that we consider reliable, but
we do not represent that it is accurate, complete or up to date, and it should not be relied on as such. Opinions
expressed are our current opinions as of the date appearing on this material and only represent the views of the
author and not those of Goldman Sachs, unless otherwise expressly noted.

Consider the investment objectives, risks, and charges and expenses of the ETFs and ETNs carefully
before investing: Each ETF and ETN has filed a registration statement (including a prospectus) with the SEC
which contains this and other information about the ETF or ETN as applicable. Before you invest in an ETF or
ETN, you should obtain and read carefully the prospectus in the registration statement and other documents the
issuer has filed with the SEC for more complete information about the product. You may get these documents for
free by visiting EDGAR on the SEC website at www.sec.gov. Alternatively, you may obtain a copy of the
prospectus for each of the ETFs and ETNs mentioned in these materials by (i) contacting your Goldman Sachs
sales representative or by sending a request by (ii) calling toll-free 1-866-471-2526, or (iii) sending a request by
email to Propsectus-ny@ny.email.gs.com, by fax to (212) 902-9316, or by mail to Goldman Sachs, 85 Broad
Street, NY, NY, 10004, Attn: Prospectus Department.
ETFs are redeemable only in Creation Unit size aggregations and may not be individually redeemed; are
redeemable only though Authorized Participants; and are redeemable on an "in-kind" basis. The public trading
price of a redeemable lot of the ETFs may be different from its net asset value. These ETFs can trade at a
discount or premium to the net asset value. There is always a fundamental risk of declining stock prices, which
can cause losses to your investment.

Legal Entities Disseminating this Material: This material is disseminated in Australia by Goldman Sachs
JBWere Pty Ltd (ABN 21 006 797 897) on behalf of Goldman Sachs; in Canada by Goldman Sachs Canada Inc.
regarding Canadian equities and jointly by Goldman, Sachs & Co. and Goldman Sachs Execution & Clearing,
L.P. regarding all other materials; in Hong Kong by Goldman Sachs (Asia) L.L.C.; in Japan by Goldman Sachs
Japan Co., Ltd.; in the Republic of Korea by Goldman Sachs (Asia) L.L.C., Seoul Branch; in New Zealand by
Goldman Sachs JBWere (NZ) Limited on behalf of Goldman Sachs; in Singapore by Goldman Sachs (Singapore)
Pte. (Company Number: 198602165W); in Europe by Goldman Sachs International (unless stated otherwise); in
France by Goldman Sachs Paris Inc. et Cie and/or Goldman Sachs International; in Germany by Goldman Sachs
International and/or Goldman, Sachs & Co. oHG; in Brazil by Goldman Sachs do Brasil Banco Múltiplo S.A.; and
in the United States of America, unless otherwise noted, by each of Goldman, Sachs & Co. and Goldman Sachs
Execution & Clearing, L.P. (both of which are members NASD, NYSE and SIPC). Goldman Sachs International,
which is authorized and regulated by the Financial Services Authority, has approved this material in connection
with its distribution in the United Kingdom and European Union. Unless governing law permits otherwise, you
must contact a Goldman Sachs entity in your home jurisdiction if you want to use our services in effecting a
transaction in the securities mentioned in this material.

Reproduction and Re-Distribution: No part of this material may be (i) copied, photocopied or duplicated in any
form by any means or (ii) redistributed without our prior written consent.

GOLDM AN S ACHS ELECTRONIC TRADING STRATEGIES | STREET COLOR 9