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Eurex Spread Trading Equity Index Futures Master

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Eurex Spread Trading Equity Index Futures Master

  1. 1. Techniques and Methodologies for Spread Trading Eurex Equity Index Futures April 2009
  2. 2. Objectives <ul><li>Presentation Focuses on Structure and Strategy </li></ul><ul><li>Create, Trade, and Manage Spreads with the DJ Euro Stoxx 50 and Dax Index Futures </li></ul><ul><li>Identify and Understand the Metrics Unique to Implied Spread Trading </li></ul><ul><li>Strategies and Tactics for Trading Implied Spreads </li></ul>
  3. 3. Objectives <ul><li>Create, Trade, and Manage Spreads with the DJ Euro Stoxx 50 and Dax Index Futures </li></ul><ul><ul><li>Benefits to Discretionary Traders </li></ul></ul><ul><ul><li>Background of products (DJ Euro Stoxx 50, Dax, ES) </li></ul></ul><ul><ul><li>Dual Factor and Multi-Factor Spreads </li></ul></ul><ul><ul><li>Walk Through Process of Building a Spread </li></ul></ul><ul><ul><li>Contract Ratios </li></ul></ul><ul><ul><li>Charting of Spread </li></ul></ul>
  4. 4. Identify and Understand the Structural Metrics Unique to Implied Spread Trading <ul><li>Dealing with Mishedges/Partial Fills/Double Fills </li></ul><ul><li>Identifying Work-Arounds for Excessive Quoting/Messaging </li></ul><ul><li>Determining Payup Ticks </li></ul><ul><li>Working One Leg or Multiple Legs </li></ul><ul><li>Spread Trading Software </li></ul>
  5. 5. Strategies for Trading Spreads <ul><li>Alpha Generating Strategies </li></ul><ul><li>Trade Factor Analysis </li></ul>
  6. 6. Background <ul><li>John Netto </li></ul><ul><li>Chief Investment Strategist, NetBlack Capital, CTA </li></ul><ul><li>Author, “One Shot – One Kill Trading” (McGraw-Hill, 2004) </li></ul><ul><li>President, M3 Capital, LLC (Introducing Brokerage Firm) </li></ul><ul><li>Avid Poker Player and Sports Handicapper </li></ul><ul><li>Speak Japanese and Chinese </li></ul><ul><li>Live in NYC and Las Vegas </li></ul><ul><li>Nine Years in US Marines </li></ul>
  7. 7. Create, Trade, and Manage Spreads <ul><li>Benefits for a Discretionary Trader </li></ul><ul><li>Watch Money Flows in Market </li></ul><ul><li>Gain Sense of Relative Strength </li></ul><ul><li>Track Volatility </li></ul><ul><li>Insight to Risk Aversion/Risk Appetite </li></ul><ul><li>Benefit to Currency Traders with Country Specific News </li></ul><ul><li>Upward Sloping Yield Curve </li></ul><ul><li>Widening Contango or Flattening Forward Curve </li></ul>
  8. 8. Create, Trade, and Manage Spreads <ul><li>Presentation will focus on spreading </li></ul><ul><ul><li>Dax Index Futures (FDAX) </li></ul></ul><ul><ul><ul><li>30 German stocks </li></ul></ul></ul><ul><ul><li>Dow Jones Euro Stoxx 50 (FESX) </li></ul></ul><ul><ul><ul><li>France (19), Germany (13), Italy (6), Spain (6), Netherlands (4), Belgium (1), and Finland (1) </li></ul></ul></ul><ul><ul><ul><li>Banks, Utilities, Telco </li></ul></ul></ul><ul><ul><li>S & P 500 Futures (ES) </li></ul></ul><ul><ul><ul><li>Widely followed US Equity benchmark </li></ul></ul></ul>
  9. 9. Components of Dax Index Ticker Name % Weight in the Index Shares in the Index DAX DAX ADS GY Equity Adidas AG 1.257489 11.87955 ALV GY Equity Allianz SE 7.719982 27.81189 BAS GY Equity BASF SE 5.843517 56.38368 BAY GY Equity Bayer AG 6.844599 46.92168 BMW GY Equity Bayerische Motoren Werke AG 2.048232 19.73416 BEI GY Equity Beiersdorf AG 0.599685 5.00448 CBK GY Equity Commerzbank AG 0.824506 40.73869 DAI GY Equity Daimler AG 5.471115 53.76103 DBK GY Equity Deutsche Bank AG 5.493751 34.50022 DB1 GY Equity Deutsche Boerse AG 2.358737 11.97068 LHA GY Equity Deutsche Lufthansa AG 1.049882 28.11193 DPW GY Equity Deutsche Post AG 1.934299 51.58235 DTE GY Equity Deutsche Telekom AG 6.83274 182.86181 EOAN GY Equity E.ON AG 9.90961 111.95205 FME GY Equity Fresenius Medical Care AG & Co KGaA 1.308148 11.4994 FRE3 GY Equity Fresenius SE 0.686946 4.94616 HNR1 GY Equity Hannover Rueckversicherung AG 0.366743 3.68533 HEN3 GY Equity Henkel AG & Co KGaA 0.832376 10.93708 SDF GY Equity K+S AG 1.323569 7.55626 LIN GY Equity Linde AG 2.232391 10.34325 MAN GY Equity MAN AG 1.018618 6.38916 MRK GY Equity Merck KGaA 1.032586 4.05831 MEO GY Equity Metro AG 0.777938 6.79067 MUV2 GY Equity Muenchener Rueckversicherungs AG 4.702324 12.03721 RWE GY Equity RWE AG 5.576428 25.01387 SZG GY Equity Salzgitter AG 0.51455 2.34341 SAP GY Equity SAP AG 5.787464 51.4801 SIE GY Equity Siemens AG 9.205364 50.05453 TKA GY Equity ThyssenKrupp AG 1.427811 20.51034 VOW GY Equity Volkswagen AG 5.018599 5.29206
  10. 10. Background of Products – DJ Euro Stoxx Components
  11. 11. Background of Products – DJ Euro Stoxx Components
  12. 12. Overlapping Stocks Between Dax and Euro Stoxx 50 ALV GY Equity Allianz SE BAS GY Equity BASF SE BAY GY Equity Bayer AG DAI GY Equity Daimler AG DBK GY Equity Deutsche Bank AG DB1 GY Equity Deutsche Boerse AG DTE GY Equity Deutsche Telekom AG EOAN GY Equity E.ON AG MUV2 GY Equity Muenchener Rueckversicherungs AG RWE GY Equity RWE AG SAP GY Equity SAP AG SIE GY Equity Siemens AG VOW GY Equity Volkswagen AG
  13. 13. Components of DJ Euro Stoxx 50 and Dax Index
  14. 14. Create, Trade, and Manage Spreads <ul><li>Dual Factor and Multi-Factor Spreads </li></ul><ul><li>Dual Factor Spread </li></ul><ul><ul><li>Comprised of two legs </li></ul></ul><ul><ul><li>Long FESX / Short FDAX </li></ul></ul><ul><li>Multi-Factor Spread </li></ul><ul><ul><li>Comprised of three or more legs </li></ul></ul><ul><ul><li>Long ES, Short FESX and Short FDAX </li></ul></ul>
  15. 15. Create, Trade, and Manage Spreads <ul><li>Walk through process of building a spread </li></ul><ul><li>Independent Leg/Dependent Leg </li></ul><ul><li>Identify Liquid Leg/illiquid Leg </li></ul><ul><li>Equalize/Normalize the Spread </li></ul><ul><li>Determine Contract Ratios </li></ul>
  16. 16. Identifying the Independent/Dependent Legs <ul><li>Independent (Primary) Leg (FESX) </li></ul><ul><ul><li>Price of implied spread is based on this leg </li></ul></ul><ul><ul><li>When buying spread, going long this leg </li></ul></ul><ul><ul><li>When selling spread, going short this leg </li></ul></ul><ul><li>Dependent (Secondary) Leg (FDAX) </li></ul><ul><ul><li>When buying the spread, going short this leg </li></ul></ul><ul><ul><li>When selling the spread, going long this leg </li></ul></ul>
  17. 17. Identify illiquid/Liquid Legs of Spread <ul><li>Intermarket spreads - time of day is key </li></ul><ul><ul><li>Follow pools of liquidity and volatility around the globe </li></ul></ul><ul><ul><li>3 AM Central Time, more liquidity in Eurex </li></ul></ul><ul><ul><li>1 PM Central Time, more liquidity in US Exchanges </li></ul></ul><ul><li>Intramarket spreads (all Eurex products) </li></ul><ul><ul><li>Should use more illiquid leg to work order </li></ul></ul><ul><ul><li>E.g. FESX/FDAX – FESX more liquid leg / FDAX is illiquid leg </li></ul></ul>
  18. 18. Equalize or Normalize the Spread <ul><li>Quantifying the relationship between two products to create synthetic value </li></ul><ul><ul><li>Proper normalization allows for trader to accurately assess the relative strength between the independent and dependant legs. </li></ul></ul><ul><ul><li>Normalization ratios are input into spread trading software to chart relationship </li></ul></ul>
  19. 19. Example : FESX/FDAX Spread
  20. 21. Example : FSEX/FDAX Spread
  21. 22.
  22. 24. Create, Trade, and Manage Spreads <ul><li>Chart of Spread – FESX-FDAX </li></ul>
  23. 25. DJ Euro Stoxx 50, Dax, ES, NQ, TFE (Mini Russell) - Last 30 Calendar (23 Trading) Days - 4-24 Contract Range (Point/Ticks) Range (Currency) Range (US Dollars) Totals TFE 202 2020 2020 NQ 42 840 840 ES 27 1350 1350 FDAX 138 3450 4586 FESX 73 733 995
  24. 26. Create, Trade, and Manage Spreads <ul><li>Contract Ratios </li></ul>Lead Leg ES FDAX FESX NQ FDAX 2/7 N/A 2/9 1/5 ES N/A 7/2 7/10 2/3 FESX 10/7 9/2 N/A 5/6
  25. 27. Structural Metrics Unique to Implied Spread Trading <ul><li>Dealing with Double Fills/Mishedges/Partial Fills </li></ul><ul><li>Double Fills – As a result of changing orders b/t exchange and trading software, risk of multiple fills and either short or long position in market takes place </li></ul><ul><ul><li>How do double fills happen? Working both legs in an attempt to maintain queue preference </li></ul></ul><ul><ul><li>Premium placed on server location, speed of transmissions </li></ul></ul><ul><ul><li>Check message turnaround time </li></ul></ul><ul><li>Example: Working both legs of Long FESX/FDAX spread </li></ul><ul><ul><li>Near simultaneous fills take place of long 9 FESX and short 2 FDAX </li></ul></ul><ul><ul><li>Spreading software will send hedge orders of corresponding leg, in essence selling 2 more FDAX and buying 9 more FESX </li></ul></ul><ul><ul><li>The result can be long 18 FESX, short 4 FDAX or somewhere in between </li></ul></ul>
  26. 28. Mishedges/Hung Legs <ul><li>Working a spread and having one leg filled and other leg unfilled </li></ul><ul><li>Example: Working long 10 x 7 FESX/ES spread </li></ul><ul><ul><li>Filled on long 10 of FESX, while short 7 of ES is still working </li></ul></ul><ul><ul><li>Hang risk larger for more volatile markets or news events </li></ul></ul><ul><ul><li>Addresses issue of payup tick logic </li></ul></ul><ul><ul><li>Contract ratio logic per hang risk </li></ul></ul>
  27. 29. Partial Fills <ul><li>Partial Fills – While working a spread, only part of the leg is filled leaving you vulnerable to systemic risk </li></ul><ul><ul><li>If partial takes place in general market trend, usually more flexible to let it work </li></ul></ul><ul><ul><li>If partial takes place against trend, more aggressive to flatten out </li></ul></ul><ul><li>Example – Working a long 9 x 2 FESX/FDAX spread and 3 contract buys on FESX leg are filled. </li></ul><ul><ul><li>Not enough to hedge out with 1 big Dax, but still market risk </li></ul></ul><ul><ul><li>Solutions </li></ul></ul><ul><ul><ul><li>Accept the risk and stay long </li></ul></ul></ul><ul><ul><ul><li>Close position with 3 lot sell on FESX </li></ul></ul></ul><ul><ul><ul><li>Hedge out with ES </li></ul></ul></ul>
  28. 30. Structural Metrics Unique to Implied Spread Trading <ul><li>Identifying Work-Arounds for Excessive Quoting/Messaging </li></ul><ul><ul><li>Excessive messaging can slow system performance/negatively impacts market participants/increases capacity requirements and costs </li></ul></ul><ul><li>A message – any Order, Modification, or Cancel for a product </li></ul><ul><li>Understanding the Volume Ratio </li></ul><ul><ul><li>Dividing total number of messages by total executed volume </li></ul></ul><ul><li>Notices and Surcharges </li></ul><ul><ul><li>Firm is fined $2,000 per occurrence as technology surcharge and potentially more if issue occurs consistently </li></ul></ul><ul><li>Potential Solutions </li></ul><ul><ul><li>XTrader AutoSpreader – Smart Quote Limits </li></ul></ul><ul><ul><li>CQG – Ninja Mode which works orders later </li></ul></ul><ul><ul><li>FCM – If FCM (Class A firm) is doing lots of volume it can help offset excessive messaging </li></ul></ul><ul><ul><li>Reference: </li></ul></ul><ul><ul><li>Eurex Circular February 9, 2009 “Adjustment of the Architecture Throttle…” </li></ul></ul><ul><ul><li>http://www.cmegroup.com/globex/files/CMEMessagingPolicy.pdf </li></ul></ul>
  29. 31. Structural Metrics Unique to Implied Spread Trading
  30. 32. Structural Metrics Unique to Implied Spread Trading - Determining Payup Ticks <ul><li>Why are Payup Ticks So Important? </li></ul><ul><ul><li>Executing strategy is pinned against fills at implied prices </li></ul></ul><ul><ul><li>High volume game and slippage can significantly detract from efficacy of strategy </li></ul></ul><ul><li>Spreads Don’t Happen in Vacuum </li></ul><ul><ul><li>Same dynamics which create opportunities create obstacles </li></ul></ul><ul><li>Strategies – </li></ul><ul><ul><li>Set Threshold for max slippage for each transaction </li></ul></ul><ul><ul><li>Set Limit plus </li></ul></ul><ul><ul><li>Set Trailing plus </li></ul></ul><ul><ul><li>Work market on side of direction you think market is headed </li></ul></ul><ul><ul><ul><li>E.g.. If working Long FESX-FDAX spread and market is rallying, work long leg (FESX) and use short leg with no payup ticks. i.e. get hung long in rising market, not hung short… </li></ul></ul></ul>
  31. 33. Structural Metrics Unique to Implied Spread Trading <ul><li>Factors in Working One Leg or Multiple Legs </li></ul><ul><li>Liquidity </li></ul><ul><ul><li>Deeper markets make multiple leg quoting potentially more beneficial as queue preference materially impacts performance of active trading </li></ul></ul><ul><li>Volatility </li></ul><ul><ul><li>More volatile the market, greater risk for mishedging </li></ul></ul><ul><li>Messaging/Quoting Limits </li></ul>
  32. 34. Background <ul><li>Patrick S Hemminger </li></ul><ul><li>Head Equity Index / Commodity Trader at NetCap Advisors </li></ul><ul><li>8 years Experience Managing Proprietary Portfolios </li></ul><ul><li>Experience trading </li></ul><ul><ul><li>Equity Indexes </li></ul></ul><ul><ul><li>Commodities (Oil, Products, Grains, Meats) </li></ul></ul><ul><ul><li>Currencies (Spot, Futures) </li></ul></ul><ul><ul><li>Treasuries (Futures, Cash) </li></ul></ul>
  33. 35. Alpha Generating Spread Strategies <ul><li>Eurex vs. Eurex and Non-Eurex vs. Eurex Spreads </li></ul><ul><ul><li>FESX vs. FDAX </li></ul></ul><ul><ul><li>ES vs. FDAX </li></ul></ul><ul><ul><li>ES vs. FESX </li></ul></ul><ul><li>Trade Factor Analysis </li></ul><ul><li>Pre – Trade Analysis </li></ul><ul><ul><li>Identifying Areas of Value </li></ul></ul>
  34. 36. Spread Examples FESX vs. FDAX
  35. 37. ES vs. FDAX
  36. 38. ES vs. FESX
  37. 39. ES / FESX / DAX Fly
  38. 40. Trade Factor Analysis <ul><ul><li>Normalizing, why? </li></ul></ul><ul><ul><ul><li>Cohesion / relationship </li></ul></ul></ul><ul><ul><ul><li>Replication </li></ul></ul></ul><ul><ul><li>Normalization Factors </li></ul></ul><ul><ul><ul><li>Instrument Tick Value </li></ul></ul></ul><ul><ul><ul><li>Instrument Notional Value </li></ul></ul></ul><ul><ul><ul><li>Instrument Base Currency </li></ul></ul></ul><ul><ul><ul><li>Instrument Historical Volatility </li></ul></ul></ul><ul><ul><ul><ul><li>60 Day </li></ul></ul></ul></ul><ul><ul><ul><ul><li>30 Day </li></ul></ul></ul></ul>
  39. 41. Trade Factor Analysis <ul><ul><li>Benchmarking - ES </li></ul></ul><ul><ul><ul><li>Global Equity Index Benchmark, the Standard </li></ul></ul></ul><ul><ul><ul><li>Provides focus </li></ul></ul></ul><ul><ul><ul><li>Manage Expectations / Performance </li></ul></ul></ul><ul><ul><ul><li>Most Liquid </li></ul></ul></ul><ul><ul><ul><ul><li>ES – 100MA = 2.5 MM per day </li></ul></ul></ul></ul><ul><ul><ul><ul><li>FESX – 100MA = 1.5 MM per day </li></ul></ul></ul></ul><ul><ul><li>Currency Component </li></ul></ul><ul><ul><ul><li>Instrument Base Currency </li></ul></ul></ul><ul><ul><ul><li>Residual Balance Strategy – Intraday / End of Day </li></ul></ul></ul><ul><ul><ul><ul><li>Hedge w/ Future </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Exchange for Physical (EFP) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Spot Transaction </li></ul></ul></ul></ul>
  40. 42. Pre-Trade Analysis - KISS <ul><ul><li>Beta - Quick and Simple </li></ul></ul><ul><ul><ul><li>Gauging Price Fluctuations </li></ul></ul></ul><ul><ul><ul><li>Where is the Risk / Volatility - Time </li></ul></ul></ul><ul><ul><ul><li>Benchmark </li></ul></ul></ul><ul><ul><ul><li>Relationship between Dependent & Independent </li></ul></ul></ul><ul><ul><ul><li>Liquidity </li></ul></ul></ul>
  41. 43. Pre-Trade Analysis <ul><ul><li>Time of Day Analysis </li></ul></ul><ul><ul><ul><li>Be Aware of Open and Close Times </li></ul></ul></ul><ul><ul><ul><li>Organize Day </li></ul></ul></ul><ul><ul><ul><li>Time Brackets </li></ul></ul></ul><ul><ul><ul><ul><li>9 Separate Brackets </li></ul></ul></ul></ul><ul><ul><ul><li>Time of Day for Opportunities </li></ul></ul></ul><ul><ul><ul><li>Probabilities </li></ul></ul></ul>
  42. 44. Pre-Trade Analysis <ul><ul><li>Long Term Standard Deviation Analysis </li></ul></ul><ul><ul><ul><li>Bollinger Bands </li></ul></ul></ul><ul><ul><ul><li>+/-1 = Momentum </li></ul></ul></ul><ul><ul><ul><li>+/-2.5 </li></ul></ul></ul><ul><ul><ul><li>Distance Between Bands </li></ul></ul></ul><ul><ul><ul><li>Slope of Bands </li></ul></ul></ul><ul><ul><ul><li>Historical Effectiveness </li></ul></ul></ul><ul><ul><ul><li>Coast - to - Coast </li></ul></ul></ul>
  43. 45. Bollinger Band Example
  44. 46. Market Profile <ul><ul><li>Long Term Standard Deviation Analysis </li></ul></ul><ul><ul><ul><li>Time Price Opportunities </li></ul></ul></ul><ul><ul><ul><li>Point of Control </li></ul></ul></ul><ul><ul><ul><li>Value Area High (VAH) </li></ul></ul></ul><ul><ul><ul><li>Value Area Low (VAL) </li></ul></ul></ul>
  45. 47. Market Profile Example
  46. 48. Technical's <ul><ul><li>Trend lines </li></ul></ul><ul><ul><li>Double Tops / Bottoms </li></ul></ul><ul><ul><li>Fibonacci Retracements </li></ul></ul><ul><ul><li>Slow Stochastic </li></ul></ul><ul><ul><li>Complimentary Markets </li></ul></ul><ul><ul><li>Top Down Approach </li></ul></ul>
  47. 49. Technicals Trend lines / Double Tops / Double Bottoms
  48. 50. Technical's Fibonacci Retracements
  49. 51. Technical's Fibonacci Retracements
  50. 52. Technical's Slow Stochastic (SStoch)
  51. 53. Technical's Complimentary Markets <ul><ul><li>Be Cognizant of Constituents </li></ul></ul><ul><ul><li>Identify Sectors Under / Out Performing </li></ul></ul><ul><ul><li>What markets are in the news </li></ul></ul><ul><ul><li>Currencies </li></ul></ul><ul><ul><ul><li>EURUSD </li></ul></ul></ul><ul><ul><ul><li>GBPUSD </li></ul></ul></ul><ul><ul><ul><li>EURJPY </li></ul></ul></ul><ul><ul><li>Be aware of Constituents in the Commodity Industry </li></ul></ul><ul><ul><ul><li>Oil </li></ul></ul></ul><ul><ul><ul><li>Gold </li></ul></ul></ul>
  52. 54. Technical's Top Down Approach <ul><ul><li>Anchor Charts </li></ul></ul><ul><ul><ul><li>Daily / 30 min / 5 min </li></ul></ul></ul><ul><ul><li>Trade on the side of the market </li></ul></ul><ul><ul><li>Contrarian positions </li></ul></ul><ul><ul><ul><li>Managing Risk </li></ul></ul></ul><ul><ul><ul><li>Take a loser, Opportunity Cost </li></ul></ul></ul><ul><ul><li>Tape Read / Feel </li></ul></ul>
  53. 55. Contact Information <ul><li>John Netto </li></ul><ul><li>[email_address] </li></ul><ul><li>212-315-0650 </li></ul><ul><li>www.osoktrading.com </li></ul><ul><li>www.netblackcapital.com </li></ul><ul><li>www.m3capital.com </li></ul><ul><li>Capital allocations, consulting, boutique brokerage services, sell-side / buy-side conferences, trader education </li></ul>
  54. 56. Contact Information <ul><li>Patrick S Hemminger </li></ul><ul><li>[email_address] </li></ul><ul><li>630.723.4730 </li></ul>
  55. 57. © Eurex 2009 Deutsche Börse AG (DBAG), Clearstream Banking AG (Clearstream), Eurex Frankfurt AG, Eurex Clearing AG (Eurex Clearing) as well as Eurex Bonds GmbH (Eurex Bonds) and Eurex Repo GmbH (Eurex Repo) are corporate entities and are registered under German law. Eurex Zürich AG is a corporate entity and is registered under Swiss law. Clearstream Banking S.A. is a corporate entity and is registered under Luxembourg law. U.S. Exchange Holdings, Inc. and International Securities Exchange Holdings, Inc. (ISE) are corporate entities and are registered under U.S. American law. Eurex Frankfurt AG (Eurex) is the administrating and operating institution of Eurex Deutschland. Eurex Deutschland and Eurex Zürich AG are in the following referred to as the “Eurex Exchanges”. 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