Race Against the Machines! The Stock Market is no longer run by humans. It is run by matching engines in computers. The stock exchanges are now server farms and the capital markets have been fragmented. The speed of transactions is now the competitive advantage in trading, only limited by the speed of light. The economic value of time in finance has exploded. Time is truly money. The tale of high frequency trading HFT and the building of the straight fiber link between Chicago, the Merc, and New York, NYSE, is from the first chapter of Flash Boys by Michael Lewis. I highly recommend this book and all the other books by Mr. Lewis.

1. The Value of Time
Arbitrage and the Value of Time

2. The Value of Time
• In finance we spend a
lot of time discussing
the time value of
money
• Lets toss that concept
on its head and look at
the revolution in the
monetary value of time
and its bumping against
the physical limitations
of the speed of light

3. Napoleon Semaphore
• Napoleonic semaphore is a system of
conveying information by means of
visual signals, using towers with
pivoting shutters, also known as
blades or paddles.
• Information is encoded by the
position of the mechanical elements;
it is read when the shutter is in a
fixed position.
• The system was invented in 1792 in
France by Claude Chappe, and was
popular in the late eighteenth to
early nineteenth century.
• They were much faster than post
riders for bringing a message over
long distances, and also cheaper in
their long-term operating costs, once
constructed.

4. Speed of Information
• Pony Express
• From April 3, 1860, to
October 1861
• During its 18 months of
operation, it reduced the
time for messages to
travel between
the Atlantic and Pacific co
asts to about 10 days
• vital for tying the new
state of California with
the rest of the United
States.

5. Telegraph
• Morse Code
• The first transcontinental
telegraph completed in 1861 was
a line that connected an existing
network in the eastern United
States to a small network in
California by a link between
Omaha and Carson City via Salt
Lake City.
• It was a milestone in electrical
engineering and in the formation
of the United States of America.
• It served as the only method of
near-instantaneous
communication between the east
and west coasts during the 1860s.

6. Transcontinental Railroad
• 1,907-mile (3,069 km)
contiguous railroad line
constructed in the United
States between 1863 and
1869 west of
the Mississippi and Misso
uri Rivers to connect the
Pacific coast at San
Francisco Bay with the
existing eastern U.S. rail
network at Council Bluffs,
Iowa.

7. Telephone

8. Financial Markets
• Ticker Tape
• Telephone
• Quotron

9. Arbitrage
• The simultaneous purchase
and sale of an asset in order
to profit from a difference
in the price. It is a trade that
profits by exploiting price
differences of identical or
similar financial
instruments, on different
markets or in different
forms.
• Trade futures contracts in
Chicago against the present
price of the individual stacks
trading in New York

10. Chicago Mercantile Exchange
• “the Merc"
• Futures Markets
• the Merc trades several
types of financial
instruments: interest
rates, equities, currencies,
and commodities.
• It has the
largest options and futures
contracts open
interest (number of
contracts outstanding) of
any futures exchange in the
world.

11. New York Stock Exchange
• NYSE
• The world clings to an
old mental picture of
the stock market

12. Arbitrage
• Every day thousands of
moments when prices
out of whack
• Sell Future contract for
more than the price of
the stock that
comprised it
• To capture the profit
you had to be FAST to
both markets at once.

13. Fast
• What it means to be
“fast’ changed
• Before 2007 speed of a
trade had human limits
• Human beings worked
on the floor of the
exchanges and trades
had to pass through
them

14. After 2007
• The exchanges simply
stacks of computers in
data centers
• Trade speed no longer
constrained by people.
• Only constraint was
how fast an electronic
signal could travel
between Chicago and
New York

15. Precise Distance
• Between the data
center in Chicago that
housed the Merc and a
data center beside the
Nasdaq’s stock
exchange in Carteret,
New Jersey

16. Fiber Optic Cable
• Speed Limit:
• Speed of Light
• 186,000 miles per
second
• Theoretically possible to
round trip Chicago-NYC
in roughly 12
milliseconds

17. Time
• Millisecond: one
thousandth of a second
• Microsecond: one
millionth of a second
• Nanosecond: one
billionth of one second

18. Telecom Carriers
• Verizon
• ATT
• Level 3
• 16-17 milliseconds
• Verizon “Gold Route”
14.65 milliseconds
• Telecom carriers not set
up to understand the
new demand for speed

19. Fortune
• Exploit the
discrepancies between
prices in Chicago and
NYC
• Financial markets had
changed, radically, the
value of a millisecond

20. Straight Line
• Allegheny Mountains
• Western Pennsylvania
• Blue rock: hard
limestone
• Build a $300 million
straight tunnel

21. Selling Speed
• Only valuable to the
extent it is scarce
• What was the degree of
scarcity that would
maximize the line’s
market value?
• How much is it worth to
a single player?
• 25 players?

22. Price & Sell Service
• How to price
• Exploit the
discrepancies between
price Thing A in Chicago
and Thing A in New York
• $20 billion per year
• 400 firms
• only places for 200 of
them on the line

23. Price
• $14 million per year
• Five year contract
• Grand total of $2.8
billion per year