WELCOMETO THE 12TH MCINTIRE HEDGE

TOURNAMENTRules of the Tournament

Official source – Do not print!(c) 2002-2011 Stefano Grazioli & Bill Wilhelm

Outline► Tournament Objective► Trading► Bookkeeping► Technology► Recommendations

The Basics► When?

Apr 27th, 5:30am-8:30pm (possible delays).► Where?

McIntire Financial Center & Lab (reserved).► Who?

Teams of 1-3 (max), open to all UVA students.► Why?

It substitutes the final It is an opportunity to learn hands-on about the intersection

of Finance and IT. Winners will get an A+ It is a great story to tell recruiters.

Teams (MS Commerce)

► I assume that you are in option #4 until you tell me differently in writing. ► Option choices are final. Only declared teams can do team submissions.

Options Learning benefits Grading Logistics

#1 Participate in the HT in your current 3 person team

Acquire high competence in Excel & Finance by participating in the Tournament. Unique & exceptional learning experience.

Up to A+Easiest to meet and split tasks - recommended

#2 Form a new team with 1, 2 or 3 people

Up to A+Matching enthusiasm & commitmentIndividual OR team

#3 Write a 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 AIndividual task (require also completing all homework)

#4 Completing as an individual the homework series

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

Up to B+ Individual task

Teams (4230 and 7770)►One, two, or three people►Ghosts► Lone Wolves

►No past winners (or their code)

►Team Composition is due by next class

You do the talking►Name►Year, School►What do you hope to get from the

class►Things you like about the class►Things that can be improved►Tournament attitude / team

formation

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

Hedging Tournament► You will hedge a portfolio of stocks

and options. That means that you will make investments to reduce the risk of adverse market movements in your portfolio. Typically, hedging is done by taking offsetting positionsin related securities.

Basic Architecture

Fin. Data FeedsFin. InfoPositions

Initial positions,Market prices, Risk free rate…

Trades

Updated Positions

Yourteam

Securities in the Tournament► about 12 Stocks► about 240 European options (12

stocks x 2 types x 2 expirations x 5 strike prices)

List of Stocks► Aapl► Goog► Dis► C► T► IBM► P&G► MSFT► XOM► KO► AMZN► YUM

Your Initial Portfolio (IP)►Stock and options on the companies

included in the Tournament + Capital account (cash)

►About $50~75 mil►You cannot change the net quantities on the

tickers/symbols in your IP. You must cash / pay dividends on those stocks, and may exercise options if any of them expire during the tournament.

OBJECTIVE

Objective► Minimize liquidity risk while producing a target rate

of return. This means keeping your Total Tracking Error as small as possible, ideally zero.

► Total Tracking Error TTE = sum of all TEs, measured every Sunday.

► Tracking Error TE = |TaTPV – TPV| if TaTPV > TPV (i.e., loss)

|TaTPV – TPV|/4 if TaTPV < TPV (i.e., gain)

► Target Total Portfolio Value TaTPVt = TPVatStart * ert

► Total Portfolio Value TPVt = Capital Accountt + Portfolio Value(including IP) t

TPV

►Portfolio Value =Sum of (Sec. Value * Sec.

Quantity)

►Two methods to assess value of a security Mark to market method

(if you have bid and ask prices) Pricing models (if you do not)

Tournament Winners►The team who at the end of the trading

period has the Lowest Total Tracking Error wins the Tournament.

► Official winners nominated during the next class.► Trade records will be audited. Rankings

may change as a result of the discoveryof errors and irregularities.

► Tournament grade depends onplacement, number and size of errors,and system quality. Many can do well.

Tournament Timeline

The 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

TRADING

Transactions and Trades

Transaction(trade)

ConfirmationTicket

(next day, i.e. next minute)

SYSTEM

YOU

Types of Transaction► Buy► Sell► SellShort► CashDiv► X-Put► X-Call

► Only these six transaction codes are valid.► Copy exact spelling, including caps and spaces.

Trades► Trades are always made against cash

► If you are selling:Qty * Bid price – transaction cost = + cash

► If you are buying:Qty * Ask price + transaction cost = - cash

Transaction Costs► Depending on the type of trade, there is a transaction cost (a

commission) to pay on each trade.► The TC table 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 0.0025

Buy Options 0.0100

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.

Trade Execution► Trades are executed by posting a trade record to

the server.► Trades are irrevocable

TeamIDType

TickerQty

PriceTransactionCostTotCostOfTrade

TeamIDType

TickerQty

PriceTransactionCostTotCostOfTrade

Simplified Traderecord schema

14BuyMSFT200$40$10$8,010

14BuyMSFT200$40$10$8,010

An example

Data Dictionary for Transactions► Date = the current date found in the environment variables► TeamId = official team number found in the Bboard► Type = one of the six transaction types (see the slide in this deck for a list).

Must be spelled exactly.► Symbol = the symbol of the transacted security. For X-put and X-call it is the

option.► Qty► Price = the appropriate bid/ask. For CashDiv Dividend is the actual $ value per

share.► Cost = the cost of the transaction. Price * qty * t.c. coefficient► Tot value = qty * price +/- Cost► InterestSinceLastTransaction. Interest on the cash held since last transaction

(or beginning of the tournament if none exists). Computed as CAccount * ert -1Time is measured in years.

► CashPositionAfterTransaction.► Tot Margins. 30% of every short position that you own, assessed at mtm.► TimeStamp, RowId, Processed. Used by the system. Do not attempt to

fill/change.

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

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

► Before you exercise a short call (long put), you need to own the stock.

Margins► Must maintain cash margins = 30% of the current (mtm) value

of all short securities in your portfolio.► Margins change in time, because the mtm of the short

positions that you hold changes in time.► Margins are reassessed after each trade.► Margins (and thus the amount you can go short) are capped

to a max $ value (e.g., $10mil)

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

What To Trade?►That is the main job of the portfolio

manager in each team:

Identify a good financial strategy DELTA/GAMMA HEDGING + your mods is

highly recommended Basics will be covered in class – most will

be your own ideas about financial strategy

BOOKKEEPING

Bookeeping►You must maintain at all times an

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

►Portfolio update is done immediately after each trade.

SYMBOL UNITS

MSFT 200

IBM 100

GE 500

CapitalAccount 5,000.00

TeamPortfolio03

Exception: “Capital Account” is in $

Mark-to-Market Value►Security Mark-to-Market Value = (Bid +

Ask) / 2

►Bid = selling price►Ask = buying price►Ask > Bid. Difference is the ‘spread’ (0.1-

0.2%)

►Bid and Ask depend on market forces anddo change in time. Use the latest available Bid and Ask.

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( ) = 0e

► 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 OptionsExercise them on the Saturday following the

third Friday of the month of expiration►European options only: you can exercise

them only on that Saturday► It is like buying/selling stock @ strike, and

has a transaction cost►Can buy/sell options up to expiration day.►Cannot trade options that have a price of

$0.►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.

TECHNOLOGYHedgeTournamentALPHA is on f-sg6m-s4.comm.virginia.edu

DataBase Structure

Data FeedsMarkets

EconomicEnvironmentConditions

Transactions

Bookkeping

DataBase Structure (spr 10)

RECOMMENDATIONS

Recommendations► This is not your typical school project. This has to work for an

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

of work). You are your own customer – your instructor is here to help you, not judge you.

► Have a plan B (and C) for everything that can go wrong. Redundancy. Management.

► 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 Penalties1. Trading on non-current prices (minor)2. Failing to accurately update the books after each trade

(minor)3. Failing to accurately report and account for transaction

costs4. Monitoring other teams’ activities5. Failing to respect the margin cap6. Failing to maintain the cash max margin (severe)7. Letting the capital account go negative (most severe)8. Altering the records of another Team (most severe)9. Hacking/disrupting the database,

the server, or the network (disqualification)

Suggested To Do List► Meet. Assign roles.► Project mgmt class?► Decide on a plan of action wrt the design of the software.► Get access to DB (soon, in class)► Study DB schema. Do you understand what each piece of data is?► Gather all the formulas.► Gather volatilities / decide where to get them from.► Build the one-star system ASAP (we will cover relevant topics soon)► Prepare test data: paper/pencil► Test it (not the developer, somebody else).► Build the two-star system.► Get data to test it.► Test it► Figure out a trading strategy: what do to when you get those first (3pm) data.► Build the x-star system.► Get data to test it.► Test it.► 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 frequently for this symbol

► If something is incorrect, let me know► If in doubt, ask!►Use the discussion forum! Recently

edited slide

Constants►Trading days / year = 252► Year = 365.25

A McIntire Tradition ►You are the pioneers of what is

becominga McIntire tradition

►Help meto make it work!

And the Winner is….

Your face here.