Wall Street can't stop talking about the 'ridiculous' arrest of the 'Flash Crash' trader

Everyone on Wall Street has been talking about this week's arrest of a little-known UK-based trader on allegations that he caused the May 6, 2010 "Flash Crash." 

That's because the consensus view on the Street is that the arrest itself is absolutely ridiculous. In fact, as one trader put it, it's "beyond ridiculous."

Over the past few days, we've had several conversations with traders, quantitative analysts, and hedge fund managers. It was the topic of conversation at happy hours and charity events.

What's more, there wasn't a single person we spoke to who bought the argument that one guy wiped billions from the market in a matter of minutes by "spoofing" - a practice in which a trader orders a bunch of trades and then cancels them. It creates artificial demand and manipulates the price of a stock.

It's been almost five years since the "Flash Crash" and regulators are suddenly blaming Navinder "Nav" Sarao, a 36-year-old who trades S&P futures from his mom and dad's house in a London suburb. Yep, regulators think a guy in saggy sweatpants and Nike Airs trading from his parents' basement did it.

Sarao was arrested and charged with one count of wire fraud, 10 counts of commodities fraud, 10 counts of commodities manipulation, and one count of "spoofing" .

If convicted on all counts, Sarao could face up to 380 years in prison based on the maximum sentences for each.

Sarao was granted bail ($7.5 million). The US is currently seeking extradition.

In the meantime, Sarao has to wear an electronic monitoring tag and follow a curfew. He's also forbidden from using the Internet for any purpose, Reuters reported. His passport is being held by the police.  

According to the complaint, Sarao allegedly used an algorithm to manipulate the market for E-Mini S&P 500 futures contracts, or "E-Minis," on the Chicago Mercantile Exchange (CME).

"Sarao's alleged manipulation earned him significant profits and contributed to a major drop in the U.S. stock market on May 6, 2010, that came to be known as the 'Flash Crash,'" the Department of Justice said in a statement. "On that date, the Dow Jones Industrial Average fell by approximately 600 points in a five-minute span, following a drop in the price of E-Minis."

Eric Hunsader, who runs market analysis firm Nanex LLC, has a great replay of Sarao's trading algo. Along with most of Wall Street, he's skeptical that Sarao could've caused the 'Flash Crash.'

At the time of his arrest, Sarao was the sole employee of UK-based Nav Sarao Futures Limited. 

In old emails, Sarao described himself as an "old school point and click prop trader." He's not a high-frequency trader. 

"To this day I am still using the mouse to trade. That is how I trade, that is how I always have traded, admittedly very very fast because I have always been good with reflexes and doing things quick," Sarao wrote in an email in May 2104 responding to questions from the UK's Financial Conduct Authority (FCA).

Sarao explained that he's someone who "changes his mind very very quickly."

"... one second I am prepared to buy the limit of 2,000, the next second I may change my mind and get out. This is what is unique about my trading. I trade very large but change my mind in a second." 

In other emails, he had claimed on an average trading day that he could make $133,000.

Even his former employer, Futex, acknowledged that he was a talented trader. 

"Nav was always going to the kind of person that I believed would be legendary, potentially legendary in some way in the future," Paolo Rossi, chairman of Futex, told Bloomberg TV. 

Rossi added that Sarao had the potential "to be remembered as being one of the world's great traders."

"If he's found innocent of the allegations, then he will be the world's superstar trader."

One question bothering Wall Street all week remains - Why did regulators wait almost five years to act? Sarao had been using the trading algo in question before the "Flash Crash" and in the years after. If he was really the cause of the crash, then why did we only have one crash during that period? 

Some traders even think that regulators have an agenda. 

"My gut says he is basically being made a target because they need someone to blame for the 'Flash Crash,'" a New York-based quant trader said, adding that the case "smells of political PR." 

This is the first time we've seen charges brought forth regarding the "Flash Crash." Traders aren't the only ones with doubts. Securities lawyers also told Reuters that this case is going to be difficult to prosecute because they have to show that Sarao intentionally canceled orders.