Your Money: Stocks and ETFs roiled by Knight

The downfall of one of Wall Street's biggest trading firms by a runaway computer should prompt investors to double-check their portfolios for some popular exchange-traded funds, whose prices were roiled on Wednesday.

Knight Capital Group (symbol: KCG) is a publicly traded firm through which many retail investors' brokerage firms route their orders. For instance, until last week's debacle, when a Knight computer went rogue and wouldn't stop programmed trading for 30 minutes, Scottrade routed about a third of its customers' buy and sell orders through Knight.

LPL Financial, Genworth, TD Ameritrade, Vanguard and several hundred other much smaller brokers also routed millions of orders daily through Knight Capital - at least until last week, when Knight lost $440 million in 30 minutes when one of its trading programs went awry.

Widely owned Vanguard Utilities ETF (symbol: VTU) normally trades only a few thousand shares a day. It traded more than 5 million shares at an unusually high price that day, then crashed back down. It was hurt by the computer program trading heavily in its underlying utility holdings, such as Exelon (EXC). The drop in utilities shares also hurt Utilities Select Sector SPDR (XLU).

Knight Capital was in the news again Monday, as investors bought preferred stock that infused Knight with a much-needed $400 million.

We checked in with a local firm that has some experience with computer-driven "algorithm" trading, and they pointed out some exchange-traded funds also got hit when the computer program began pushing stock prices up and down in a haywire fashion.

Street One was founded by a former Wall Streeter named Scott Freeze. "This is an example of algorithms gone wild," said Freeze, who used to work on the very trading desk that Knight said was responsible for the breakdown. "They can't be left on autopilot."

That dragged down exchange-traded funds that held these unlucky stocks, such as Market Vectors Gold Miners ETF (GDX) and ProShares Ultra Russell2000 (UWM).

Thinly traded Market Vectors Rare Earth/Strategic Metals (REMX) exchange-traded fund averages about 87,000 shares a day and is structured to deliver exposure to companies that are involved in the mining, refining, and manufacturing of rare earth/strategic metals. Top holdings consist of relatively unknown names including ILU (8.39 percent), LYC (7.95 percent), MCP (7.36 percent), KMR (7.28 percent), and TIE (6.60 percent).

Stock of Molycorp, which deals in rare earth, inexplicably went into a free-fall, dropping from the $17 range to $14.35 for no apparent reason.

"Molycorp (MCP) stock was inadvertently hammered by Knight and one big ETF basket gone awry," says Paul Weisbruch, who works at Street One Financial in Huntingdon Valley.

Retail investors suffer when these algorithms develop "consciousness" - recall the Terminator movies - and start dragging down stocks and exchange-traded funds widely owned by regular people just trying to preserve their capital in something advertised as boring and safe.

But at least one person made money on the Knight Capital Group debacle: Freeze, of Street One, said someone bought a boatload of options on Knight Capital's stock - about 80,000 put options - "as the debacle was happening," he said. "That trade should be examined."

Put options give the investor the right to buy the stock of a company at a much lower price. Knight's stock was trading at $10 on Tuesday and now trades at about $3 a share. When they expire, the $7.50 strike price puts stand to be worth about $50 million, by Freeze's calculation.

Investing books Looking for some summer investment reading? One offering is Bill Feingold's Beating the Indexes: Investing in Convertible Bonds to Improve Performance and Reduce Risk (Minyanville Media). Another is Ali Velshi's How To Speak Money, written with Christine Romans. Velshi, of CNN fame, lives in Bryn Mawr with his wife, Lori Wachs, a Wharton grad and longtime area resident who runs a hedge fund based in Center City.