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