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Welcometo the 17th

McIntire Hedge

TournamentRules of the Tournament

March 2nd, 2016Official source – Do not print!

(c) 2002-2016 Stefano Grazioli & Bill Wilhelm

Hedging TournamentYou will hedge an illiquid portfolio of stocks and options. That means that you will make investments to reduce the risk of adverse market movements in your portfolio.

Learning Goals Help you learn broad & valuable skills in how

to use IT to solve business problems Working with IT Thinking algorithmically Accessing enterprise data (SQL, ADO, PIVOT) Mastering Excel automation (VBA, VS) Design and implement financial strategies (Hedging) It is a great story to tell recruiters.

Logistics When?

Apr 28th, 5:00pm-9:00pm (possible delays). Where?

McIntire Financial Labs (reserved). Who?

Teams of 1-3 (max) Why?

It substitutes for the final Winners will get an A+

Grading Options

I assume that you are in option #1 until you tell me differently in writing by March 27th

Option choices are final. There is no minimum guaranteed grade.

Option Learning benefits Grading Logistics

#1 Participate in the HT in a team

Acquire advanced competence in Excel, SQL & Finance by participating in the Tournament. Exceptional learning experience.

Up to A+ Recommended

#2 Write a full length paper on the use of IT tools in business

Learn how IT tools are used in a specific industry by analyzing a real-world example.

Up to A Individual task (also requires completing all homework)

#3 Completing the full homework series

Focus on other classes after the acquisition of intermediate skills in SQL and Excel.

Up to B+You will be done early. Still need to attend if you want participation points. Individual task.

Teams (4230 & GCOMM7770) Three people max Lone Wolves Lone Stars

No Team? Name Year, School Tournament attitude / team formation

Outline Tournament and its objectives Trading Accounting Technology Recommendations

Bookmasters: Read the hidden slides!

252 Securities in the Tournament 12 Stocks 240 European options (12 stocks x 2 types x

2 expirations x 5 strike prices)

Stocks in the Basket BABA AAPL DB COST LNKD

Your Initial Positions (IP) Stock and options on the companies included

in the Tournament Initial positions are illiquid. You cannot

change your net positions on the tickers/symbols in your IP. That means that you cannot trade the symbols in IP.

However, you must cash / pay dividends for the IP stocks, and may exercise IP options as appropriate.

Your Acquired Positions (AP) Stock and options on the companies included

in the Tournament that you have traded. Can be long or short

Your portfolio (~50 mil.)Total Portfolio Value (TPV) = Total value of your IP + Total value of your AP + Capital account

= value of IP positions at mark to market + value of AP positions at mark to market + Capital account.

Mark to market = (bid + ask) / 2

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WINNING THE TORNAMENT

Target Portfolio Value (TaTPV)

Target Total Portfolio Value (TaTPV)

HT Starts HT EndsTime

TaTPV

Total Portfolio Value (TPV) unmanaged

TaTPVt = TPVatStart * ert r = risk free ratet = time in years from the start of HT

Objective: Minimize risk while producing a target rate of return.Your job is to minimize the difference between your Target Total Portfolio Value TaTPV and your actual Total Portfolio Value TPV. The difference is called the Tracking Error TE.

TE = TaTPV – TPV if TaTPV > TPV (i.e., loss)

TE = |TaTPV – TPV|/4 if TaTPV < TPV (i.e., gain)Every ‘Sunday’ we measure your TE.The Total Tracking Error (TTE) is the sum of all TEs.

Tournament Winners The team who at the end of the trading

period has the lowest Total Tracking Error wins the Tournament

Section winners

Tournament Winners Official winners nominated in the next class. Trade records will be audited. Tournament grade depends on

placement, number and size of errors,and system quality. Many can do well.

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Basic Architecture

Fin. Data FeedsFin. InfoPositions

Initial positions,Market prices, Risk free rate…

TradesUpdated Positions

Yourteam

Trade Execution Trades are executed by posting

a trade record to the ‘transaction queue’

Trades are irrevocable

Types of TradesTransaction Codes

Buy Sell

SellShort CashDiv

X-Put X-Call

Only these six transaction codes are valid Copy exact spelling, including dashes and caps

Trades Trades are always made against cash

If you are selling:Tot Tr. Value = Qty * Bid price – transaction cost

If you are buying:Tot Tr. Value = -(Qty * Ask price) – transaction cost

Transaction CostsTable is in the DB

Transaction cost = Cost Coefficient * (Qty * price)

No parameter value (e.g., cost coefficients, risk free interest rate) is completely fixed. Do not hardwire them in your models. They may change from HT to HT.

Type of TradeEXAMPLE Cost

Coefficient(Find them in the DB)

Sell Short Stock 0.0250Buy Options 0.0100

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Transactions and Trades

Transaction(trade)

ConfirmationTicket

(next “day”, i.e. next minute)

SYSTEM

YOU

Tournament TimelineThe tournament begins

Tournament ends

Second set of market prices

Third set of market prices...

Start End

Market data & IP posted (neither is known in advance

First set of market prices

All times are server times

Trading ~ 3 hrs No TradeNo Trade

Trades – The fine print Securities that are listed with a price of $0

cannot be traded.

You cannot trade twice the same ticker or symbol in the same day - i.e., no “money burning.” Both trades will be rejected.

What To Trade?Main job of the portfolio manager in each team:

Identify a good financial strategy DELTA HEDGING + your mods is highly

recommended Basics will be covered in class – most will

be your own ideas about financial strategy

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t ACCOUNTING

Bookkeeping Maintain at all times an updated book

of positions (“team portfolio”) on the server.

Portfolio update is doneimmediately aftereach trade.

SYMBOL UNITSMSFT 200IBM 100GE 500CapitalAccount 5,000.00

TeamPortfolio03

Exception: “Capital Account” is in $

Pricing Models Options are priced approximately according to the BS

formulas Pput = BS (X, S, t, vol , r) + e

X = strike price S = underlier price t = time in years vol = volatility r = risk free rate e = random error (noise) E(e) = 0

Everything except the volatilities is given to you in the data feeds.

Dividends In $ Paid quarterly Not constant Need to report them (as a transaction) : use

“CashDiv” on the dividend date The owner of the stock at the beginning of

the dividend day gets the dividends You do not get dividends from short stocks.

You need to pay them on the dividend date!

Exercising Options European options only: you can exercise them only

on the Saturday following the third Friday of the month of expiration

It is like buying/selling stock @ strike, Has a transaction cost Cannot trade or exercise options that have a price

of $0. For short calls & long puts you need to have the

stock in hand There will be no short options that expire in the IPs

Interest Cash earns interest continuously Just before every transaction compute

the interest on the Capital Account Interest = CAccount * ert -1

wheret = time in years between the last transaction and this transaction.r= risk-free interest rate.

Margins You must maintain cash margins = 30% of the

current value of all short securities in your portfolio Margins change in time. Margins are reassessed

after each trade Margins are capped (e.g., MaxMargins =$10mil).

Step by step: Calculate z = S(qtyi * mtm) for the short securities in your portfolio. The margins are = 0.30 * z, so make sure that your cash position after the trade is larger than z * 0.30

Short Positions – The fine print You can sell short both stock and options. There are margin

requirements (discussed later) You may not sell short if you have a long position on the same

security.Example: you can not sellShort 250 GOOG if you hold a long position in 100 GOOG. First you sell the long position, then you go short. You must do so in two separate days.

If you have a short position in an option that is in the money at expiration, you must honor it. If not in IP, you can buy it back before expiration (easiest).

Before you exercise a short call or a long put, you need to own the stock.

If you have a short position in a stock and the dividend date comes, you need to pay dividends. Treat it as a CashDiv transaction with a negative sign

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t TECHNOLOGYThe tournament will run in HedgeTournamentALPHA on

f-sg6m-s4.comm.virginia.edu

DataBase Structure

Data FeedsMarkets

EconomicEnvironmentConditions

TransactionsBookkeping

DataBase Structure

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Team RolesYou are a small Hedge Fund Portfolio Manager CIO/CTO Bookmaster/COO PM Trader Internal Auditor

Recommendations This is not your typical school project. Your trader must work for an

extended period of time. Outcome is what matters (not program elegance or amount of

work). You are your own customer – I am here to help you, not judge you. Have a plan B (and C) for everything that can go wrong. Leadership: Assign clear role & responsibilities and deliverables to

team members. Monitor deliverables. DO NOT trust your best programmer to get it done right and in

time the night before. She/he will not. You will regret it. Freeze deliverables. Version control. Test, test, test, test.

Grounds for Penalties Trading on non-current prices (minor) Failing to accurately update the books after each trade (minor) Failing to accurately report and account for transaction costs Monitoring other teams’ activities Failing to respect the margin cap Failing to maintain the cash max margin (severe) Letting the capital account go negative (severe) Altering the records of another Team (most severe) Hacking/disrupting the database,

the server, or the network (disqualification)

Suggested To Do List Meet. Assign roles. Review the rulebook. Project mgmt class? Decide on a plan of action wrt the design of the software. Choose a team name and get access to the DB (email instructor and TA) Study the DB schema. Do you understand what each piece of data is? Gather all the formulas. Gather volatilities / decide where to get them from. Prepare test data: paper/pencil Test it (not the developer, somebody else). Figure out a trading strategy Figure out a starting strategy: what do to when you get those first (3pm) data. Understand your warm/cold start tactics Test everything. Simulate errors. Can you recover from a crash? Do a full simulation of the tournament. General System Test (participation)

Notes etc. The rules are stable. No major changes are

expected. Clarifications may occur as a result of my interaction with you.

Check this slide pack for this symbol If something is incorrect, let me know Use the discussion forum on Collab If in doubt, ask!

Recentlyedited slide

And the Winner is….Your face here.