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Succumbing to the Python in Financial Markets

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Succumbing to the Python in Financial Markets

  1. 1. Succumbing to Python in the Financial Markets<br />David Cerezo Sánchez<br />http://cerezo.name<br />
  2. 2. Python Advantages & Drawbacks<br />Interactive, expressiveness: very quick prototyping<br />Reduced development cycle: C++/Python=10:1<br />Time distribution in algorithmic trading (25% devising new strategies; 25% coding; 50% model fine-tuning and code maintenance): Python improvements impact 75% of development<br />Free, nonproprietary (vs. Matlab, TradeStation,…)<br />Multi-threading from Python 3.2!<br />SEC mandating cashflow disclosure of ABS securities in Python<br />Dynamic, not strongly typed (Java): errors at runtime!<br />
  3. 3. Must-Have Python Financial Packages<br />IbPy: Interactive Brokers Python API<br />ultra-finance, MarWiz, pyfinancial, profitpy, QSToolKit: algorithmic trading libraries<br />Quantlib-python: quantitative finance library<br />NumPy, SciPy, PyIMSL: computational, scientific, numerical libraries <br />xlrd: extract data from .xls/.xlsx files<br />RPy2: wrapper to R, allows R function execution within Python<br />
  4. 4. Code Samples<br />
  5. 5. Combo Orders with IbPy<br /># define the contract for each leg<br />shortContract= makeOptContract(‘MSFT', '', 26, '')<br />longContract= makeOptContract(‘AAPL', '', 350, '')<br /># instantiate each leg<br />shortLeg= makeComboLeg(getConId(1,shortContract), 'SELL', 1)<br />longLeg= makeComboLeg(getConId(2,longContract), 'BUY', 1)<br /># build a bag with these legs<br />calendarBagContract= makeBagContract(‘MSFT', [shortLeg, longLeg])<br /># build order to buy 1 spread at $0.5<br />buyOrder= makeOrder(‘BUY', 26, 0.5)<br /># buy! buy! buy!<br />con.placeOrder(nextOrderId, calendarBagContract, buyOrder)<br /># watch the messages for a bit<br />sleep(100)<br />
  6. 6. Basket Options with Quantlib_python<br /># Dates, risk-free rate & option parameters<br />todaysDate = Date(8,May,2011); Settings.instance().evaluationDate = todaysDate<br />settlementDate = Date(12,May,2011); riskFreeRate = FlatForward(settlementDate, 0.06, Actual365Fixed())<br />exercise = EuropeanExercise(Date(12,May,2011)); payoff = PlainVanillaPayoff(Option.Call, 10.0)<br /># Market data<br />underlying1 = SimpleQuote(8.0); volatility1 = BlackConstantVol(todaysDate, TARGET(), 0.12, Actual365Fixed())<br />dividendYield1 = FlatForward(settlementDate, 0.06, Actual365Fixed())<br />underlying2 = SimpleQuote(8.0); volatility2 = BlackConstantVol(todaysDate, TARGET(), 0.12, Actual365Fixed())<br />dividendYield2 = FlatForward(settlementDate, 0.06, Actual365Fixed())<br />process1 = BlackScholesMertonProcess(QuoteHandle(underlying1), YieldTermStructureHandle(dividendYield1),<br /> YieldTermStructureHandle(riskFreeRate), BlackVolTermStructureHandle(volatility1))<br />process2 = BlackScholesMertonProcess(QuoteHandle(underlying2), YieldTermStructureHandle(dividendYield2),<br /> YieldTermStructureHandle(riskFreeRate), BlackVolTermStructureHandle(volatility2))<br />procs = StochasticProcessVector(); procs.push_back(process1); procs.push_back(process2)<br />matrix = Matrix(2,2); matrix[0][0] = 1.0; matrix[1][1] = 1.0; matrix[0][1] = 0.5; matrix[1][0] = 0.5<br />process = StochasticProcessArray(procs, matrix)<br />basketoption = BasketOption(AverageBasketPayoff(payoff, 2), exercise)<br />basketoption.setPricingEngine(MCEuropeanBasketEngine(process,'lowdiscrepancy ',timeSteps= 1,requiredSamples =65536))<br />print basketoption.NPV()<br />
  7. 7. Bermuda Swaption with Quantlib_python<br />swaptionVols = [ (Period(1, Years), Period(5, Years), 0.12), (Period(2, Years), Period(4, Years), 0.11), (Period(3, Years), Period(3, Years), 0.10),<br /> (Period(4, Years), Period(2, Years), 0.09), (Period(5, Years), Period(1, Years), 0.08) ]<br />todaysDate = Date(8,May,2011); Settings.instance().evaluationDate = todaysDate; calendar = TARGET(); settlementDate = Date(12,May,2011);<br />rate = QuoteHandle(SimpleQuote(0.05)); termStructure = YieldTermStructureHandle(FlatForward(settlementDate,rate,Actual365Fixed()))<br />fixedLegFrequency = Annual; fixedLegTenor = Period(1,Years); fixedLegConvention = Unadjusted; floatingLegConvention = ModifiedFollowing;<br />fixedLegDayCounter = Thirty360(Thirty360.European); floatingLegFrequency = Semiannual; floatingLegTenor = Period(6,Months)<br />payFixed = VanillaSwap.Payer; fixingDays = 2; index = Euribor6M(termStructure); floatingLegDayCounter = index.dayCounter()<br />swapStart = calendar.advance(settlementDate,1,Years,floatingLegConvention); swapEnd = calendar.advance(swapStart,5,Years,floatingLegConvention)<br />fixedSchedule = Schedule(swapStart, swapEnd, fixedLegTenor, calendar, fixedLegConvention, fixedLegConvention, DateGeneration.Forward, False)<br />floatingSchedule = Schedule(swapStart, swapEnd, floatingLegTenor, calendar, floatingLegConvention, floatingLegConvention, DateGeneration.Forward, False)<br />dummy = VanillaSwap(payFixed, 100.0,fixedSchedule, 0.0, fixedLegDayCounter,floatingSchedule, index, 0.0, floatingLegDayCounter)<br />swapEngine = DiscountingSwapEngine(termStructure); dummy.setPricingEngine(swapEngine);atmRate = dummy.fairRate()<br />atmSwap = VanillaSwap(payFixed, 1000.0,fixedSchedule, atmRate, fixedLegDayCounter,floatingSchedule, index, 0.0,floatingLegDayCounter)<br />otmSwap = VanillaSwap(payFixed, 1000.0,fixedSchedule, atmRate*1.4, fixedLegDayCounter,floatingSchedule, index, 0.0,floatingLegDayCounter)<br />itmSwap = VanillaSwap(payFixed, 1000.0,fixedSchedule, atmRate*0.6, fixedLegDayCounter,floatingSchedule, index, 0.0,floatingLegDayCounter)<br />atmSwap.setPricingEngine(swapEngine);otmSwap.setPricingEngine(swapEngine);itmSwap.setPricingEngine(swapEngine)<br />helpers = [ SwaptionHelper(maturity, length,QuoteHandle(SimpleQuote(vol)),index, index.tenor(), index.dayCounter(),index.dayCounter(), termStructure) <br /> for maturity, length, vol in swaptionVols ]<br />times = dict([(t,1) for t in h.times() for h in helpers])<br />times = times.keys(); times.sort(); grid = TimeGrid(times, 30); BKmodel = BlackKarasinski(termStructure)<br />for h in helpers:<br /> h.setPricingEngine(TreeSwaptionEngine(BKmodel,grid))<br />calibrate(BKmodel, helpers, 0.05);bermudanDates = [ d for d in fixedSchedule ][:-1]; exercise = BermudanExercise(bermudanDates)<br />atmSwaption = Swaption(atmSwap, exercise);otmSwaption = Swaption(otmSwap, exercise);itmSwaption = Swaption(itmSwap, exercise)<br />tse=TreeSwaptionEngine(BKmodel, 50); atmSwaption.setPricingEngine(tse);otmSwaption.setPricingEngine(tse);itmSwaption.setPricingEngine(tse)<br />print ('Black-Karasinski numerical', itmSwaption.NPV(), atmSwaption.NPV(), otmSwaption.NPV())<br />
  8. 8. Fast implementation Investment Strategies<br />“Portable Alphas from Pension Mispricing”, Journal of Portfolio Management, Summer 2006, 44-53<br />Pure alpha strategy<br />1.51% (monthly), S=0.26<br />Just 200 lines of Python:<br />Heavy use of map, reduce, filter, lambda<br />SciPy: OLS<br />scikits.timeseries<br />Easier to implement using RPy2 (R wrapper)<br />
  9. 9. What lies ahead…<br />
  10. 10. Substitutes vs Complements Paradox<br />Quant/algo trading focused at human trader substitution, but…<br />Moravec’s Paradox: Computer’s excel where humans are weak, and vice versa <br />Vg. Advanced Chess (Computer-Augmented Chess Playing): computer chess programs allowed at human competitions<br />Computers better at brute-force position evaluation, opening and endgame databases, transposition and refutation tables… <br />Respect human common sense and judgment<br />Promoted by top players: Kasparov, Anand, Topalov, …<br />Computer-assisted Playchess.com Freestyle Chess 2005 Tournament:<br />Amateurs+computers+better process >> specialized chess supercomputers >> grandmasters+computer+inferior process<br />
  11. 11. Backtesting vs. Forward Testing<br />Why do people love backtesting so much? <br />overfitted model calibrations will always prove their strategies to have very high alpha&Sharpe ratio<br />With hindsight, everyone’s a winner<br />In HFT/algo/quant trading, forward testing should be the golden standard:<br />Extremely fast changing market conditions<br />Reverse-engineered strategies that stop working<br />
  12. 12. Market Microstructure<br />Don’t forget about optimal execution sizes!<br />Or expected trading costs given trading volume and volatility!<br />

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