All posts by Trading Technologies

Global capital markets have been in flux over the past few months, to say the least. In early April, Japanese Prime Minister Shinzo Abe launched the second arrow of “Abenomics.” After 15 years of chronic deflation, the Bank of Japan set an inflation target of 2 percent and announced a plan to buy $75 billion a month of Japanese government bonds. This led to the Nikkei index to run up by roughly 30 percent through mid-May.

Much of the money that flooded into Japan was pulled out of emerging markets. Brazil in particular reacted to try and lure foreign capital back into the country. Years ago, while the U.S. and European economies were mired in recession, Brazil put in place capital controls in the form of the IOF tax to prevent hot money inflows from strengthening the real against the dollar. Since then, the Brazilian economy has stalled, and in mid-June the Brazilian government removed most of the IOF taxes, including the 1 percent tax on derivatives.

Thus far, we have only received hints of the biggest development yet to come. Starting in April, the U.S. Federal Reserve began hinting that it would likely wind down QE3 and begin tapering its purchase of bonds later this year. Although the talk of tapering being imminent has been put to rest for now, it is only a matter of time until the Fed begins to wind down its $85 billion a month purchase of bonds. In a preview of the eventual effect tapering will have, yields on benchmark 10-year U.S. Treasuries were up more than 80 basis points from the beginning of May through the end of June.

10-Year U.S. Treasury Yield
Source: Yahoo! Finance

Taking a View Using the Swap Spread

The swap spread is a useful tool to speculate or hedge against changes in the supply and demand of the U.S. Treasury market, changes in the federal government deficit or responses to the expectation of increasing interest rates. A swap spread consists of a Treasury bond leg and an interest rate swap leg, with each leg acting as a proxy for the perceived riskiness of government debt and bank debt respectively.

When concerns arise regarding the creditworthiness of the banking system, the resulting flight to quality in Treasuries leads to a rise in the yield of interest rate swaps relative to government debt, and a widening swap spread. Conversely, if investors and credit rating agencies become concerned about the creditworthiness of government debt (not that that would ever happen…), people may pull money out of Treasuries, leading to a rise in the yield of government debt relative to bank debt and a narrowing swap spread.

Supply and demand mechanics of the Treasury market can also influence the swap spread. When a persistent federal deficit is expected, and with it the expectation of an ample supply of Treasuries, Treasury yields rise relative to swap yields and the swap spread narrows. When deficit projections decrease, expectations of a shrinking supply of Treasuries will cause spreads to widen.

U.S. Dollar 10-Year Swap Spread
Source: Bloomberg

Perhaps one of the biggest influences on the swap spread is mortgage convexity hedging. When interest rates rise, the likelihood of homeowners refinancing decreases and the duration of outstanding loans increases. In response to the increase in duration and an increase in the amount of interest they can expect to earn from mortgages, investors will look to sell long-dated assets. The effects of this hedging are more pronounced in the swaps market than the Treasury market, usually leading to a widening of swap spreads. When interest rates fall, investors will look to buy swaps, often leading to a narrowing of the swap spread.

The Invoice Spread

A swap spread trade is typically constructed by buying (or selling) a Treasury bond and paying (or receiving) the fixed rate of an interest rate swap with an identical maturity. The same trade, known as an invoice spread, can be built using Treasury futures and Eris Exchange interest rate swap futures. Using an invoice spread can result in significant margin savings of up to 75 percent compared to a swap spread using the cash products.

Eris Exchange actually lists a flex contract specifically designed to lend itself to constructing an invoice spread. The Eris invoice spread leg contract has the same maturity as the cheapest to deliver Treasury underlying the 10-year U.S. Treasury future available on either the Chicago Board of Trade (CBOT) or NYSE Liffe U.S.

Even though Eris contracts are futures, they match the cash flows of a typical over-the-counter (OTC) interest rate swap. As a result, an Eris product offers the best of both worlds: like an OTC swap, it can serve as a proxy for corporate credit risk, while also offering the capital efficiencies of a futures product.

Trade the Eris Exchange invoice spread with TT’s X_TRADER®.

The Right Tools Make All the Difference

X_TRADER® 7.17 adds functionality that will make it easy to trade the invoice spread. X_TRADER and Autospreader® have long allowed the trader to convert quotes for fixed income products—whether they be Eurodollars, Treasury futures or cash Treasuries—to an implied yield.

The Eris invoice spread leg contract has a fixed coupon, and is quoted in net present value (NPV) terms. X_TRADER 7.17 will allow you to convert this NPV-quoted price to an implied yield. The only parameter the trader needs to supply is the PV01 value for the swap, or the price sensitivity of the swap to a one-basis-point change in yield. The PV01 value for a given swap is available through many market data services.

Configuring the Eris Exchange invoice spread in TT’s Autospreader®.

Both the CBOT Treasury futures leg and the Eris swap futures leg can be converted to an implied yield, making it simple to set up the spread between the two contracts. Additional information regarding how to set up an invoice spread is available on our website. With our new functionality and our newly available access to Eris Exchange, traders looking to stay ahead of the Fed have yet another tool in their arsenal.

Web AD multibroker

I’m very excited about today’s announcement regarding the production release of the TT MultiBroker* solution. The MultiBroker* platform represents the fulfillment of our greatest commitment to the buy side. I wanted to dedicated this blog to that commitment in order to underscore the importance of the buy side to TT.

From the start, TT has focused on providing software for derivatives professionals, which include proprietary, sell-side and buy-side traders. Historically, TT’s pedigree is rooted in proprietary trading. From these origins, we gained our innate and steadfast commitment to uncompromising reliability, low latency and high throughput. And as a vendor whose direct customers are primarily banks and futures commission merchants (FCMs), TT also has catered very closely to the needs of the sell side, with products that include flexible user administration and advanced risk management capabilities. With multi-broker support, we now complete the circle by providing a broker-neutral platform for buy-side derivatives traders. Our TTNET™ hosting service spans five continents, eight data centers and more than three-dozen exchanges, and is unparalleled as a high-performance, reliable solution for trading listed derivatives.

TT connected logo
Select your broker with a single click in TT’s MultiBroker.*

Unlike some multi-broker platforms that hand off orders to third-party/sell-side execution networks, the TT MultiBroker* solution is an end-to-end architecture that guarantees an order is never routed to another network. TT software routes the order from the end user to the exchange matching engine and back, regardless of which broker is handling execution. This optimizes performance and reliability, and eliminates hard-to-diagnose issues that can occur when orders are routed across network domains.

TT’s ongoing commitment to innovation has resulted in game-changing products such as the ADL™ visual programming platform, which allows traders and quants to develop sub-millisecond algorithms on a visual canvas, test them in simulation against live market prices and route them for proximity execution to any of our global data centers—all from a single X_TRADER® workstation and without traditional and error-prone coding. The addition of multi-broker support to the TT platform takes our technology to the next level by giving end users the ultimate flexibility of choice among their execution and clearing providers.

TT connected logo

In my role as head of buy-side product management at TT, I am obviously very excited about TT’s deep commitment to hedge funds, asset managers, CTAs, pension funds and corporations. Since directing the TT Connected Partner Program is one of my responsibilities, I will reinforce this commitment by expanding relationships with complementary buy-side application vendors, such as commercial order management systems, portfolio management systems and a variety of middle-office and analytical applications that are geared to buy-side traders, quants and portfolio managers. If you’re with a firm that develops such complementary offerings for the buy side, I encourage you to consider joining the Connected Partner Program. You can indicate your interest by completing the Partner Program inquiry form on our website.

Along these lines, we’re also working on a powerful yet easy-to-use means of bridging FIX-based systems with our MultiBroker* platform through a user interface designed for non-programmers. Ultimately, this will empower more buy-side firms to connect FIX-enabled systems to TT’s trading platform with minimal effort and delay. Stay tuned for a future blog post that will outline this innovative new technology!

*TT’s MultiBroker solution is now know as X_TRADER ASP.

When considering what to cover in my first blog post, I kept coming back to topics related to spread trading. As a former full-time trader who made a living formulating and executing spread strategies, and as the person who leads the product management function for proprietary trading at TT, which includes automated trading, I think a lot about themes related to spreading.

TT’s Autospreader is one of the most widely used spread tools largely because it delivers sophisticated functionality and extreme performance in a very user-friendly package. I decided to write about dynamic hedging because I believe it’s an important concept for spread traders to understand and apply. Furthermore, I believe the way Autospreader addresses dynamic hedging with the Hedge Rule Builder tool is pretty powerful.

In this post, I’ll walk through some examples to illustrate how Hedge Rule Builder can be used to apply Pre Hedge and Post Hedge rules. But before I start on that topic, I’ll back up a bit for the benefit of readers who haven’t yet taken a deep dive into spread trading and hedging.

Spread Trading, Autospreader® and Hedge Rule Builder

The basic function of any spread trading tool, including TT’s Autospreader, is to execute orders to buy and sell a synthetic instrument composed of at least two exchange-listed securities, or “legs”. A spreader actively quotes at least one leg. When it accumulates inventory, it “hedges” by sending orders in the other leg in an attempt to buy or sell the synthetic instrument at the desired price.

Basically, a spreader performs two functions: it assumes risk, then reduces it as the spread order gets closer to completion. It provides liquidity, then seeks liquidity.

When trading a spread, hedging entails sending orders in legs as a reaction to an execution in an actively quoted leg. This is liquidity-seeking behavior, and therefore has a cost, which is mostly the price of crossing the bid-ask spread. While the main point of hedging is to reduce risk, a close second is to minimize the costs of reducing that risk.

How can we try to reduce our costs of seeking liquidity? One possibility is to vary our aggressiveness based on market conditions.

Autospreader’s Hedge Rule Builder offers two powerful ways to customize hedging behavior and aggressiveness: the Pre Hedge Rule and the Post Hedge Rule. The Pre Hedge Rule is evaluated after a quote fill but before any hedge orders are sent; the Post Hedge Rule is evaluated after hedge orders have been sent and acknowledged by the exchange. In other words, the Post Hedge Rule is only evaluated when there are “resting” hedge orders. Used together, these rules give us the opportunity to reduce liquidity costs, boosting bottom-line results.

Let’s walk through a few specific liquidity-seeking techniques to illustrate the concept.

Pre Hedge Rule

We’ll use the soybean crush for our examples. This is a common strategy where a position in soybean futures is offset by equivalent positions in soybean meal and soybean oil. We’ll define our spread as follows (using the soon-to-be-released X_TRADER® 7.17), with Hedge Round enabled to round hedging quantities rather than truncate them:

When we get a small fill on our quoting leg, we may decide to be less aggressive (where “aggressive” is defined as being less willing to cross the market) in pricing our hedge orders and making one-lots and two-lots “work for better” by applying a negative payup tick. Note that in this context, HedgeWorkingQty is the quantity Autospreader is about to submit:
Even if our hedge need is relatively large, we can be less aggressive if the opposite side bid/offer is strong:
In other cases, by detecting that the market has moved away from us, we can be more aggressive. Note that at the time of the Pre Hedge Rule’s evaluation, HedgePrc is the price Autospreader will submit before including payup ticks:

Post Hedge Rule

After hedge orders have been sent, Autospreader can monitor market conditions and react based on user-defined logic. This allows us to continue to adjust our aggressiveness in seeking liquidity based on new information. Remember that when configuring a Post Hedge Rule, we need to provide a “repeat value” if we want the behavior to be dynamic—that is, performed more than once as conditions change.

One way to keep a hedge order “competitive” is to track its price against the best price in the market. It’s easy to write a rule such that if a hedge order “falls out” of the first five price levels, we get more aggressive by attempting to cross an assumed one-tick-wide market at the new level:

We can also base our behavior on time. We can improve our price one level once a second for the first minute of being “hung”:

Conclusion

As someone who still dabbles in trading, I really appreciate the fact that the Pre Hedge and Post Hedge rules allow the user to tweak Autospreader functionality. These logic “hooks” give the trader the needed flexibility to maximize opportunity and minimize costs.

These techniques are just a few examples of what is possible, and they can even be combined into more complex behaviors.

If you’d like to explore some of the more sophisticated applications of Pre Hedge and Post Hedge rules, feel free to submit a comment on this blog post. Or, you can consult the Online Help module on our website.

As I mentioned in my last blog, X_STUDY® charts offer more than traditional bar data. Along with the open, high, low, close and volume for each bar, we have a list of volume at each traded price. This list is commonly referred to as Volume at Price, or VAP, and can be visually displayed on an X_STUDY chart. The VAP data is then used to calculate many key technical price levels like Volume Weighted Average Price (VWAP), Volume Point of Control (POC) , Value Area High (VAH) and Value Area Low (VAL).

VAP

Let’s look at VAP before we explain these important daily price levels. VAP is generally plotted on a chart to view which price levels have attracted high-volume trading and which price levels have relatively low volumes. These high- and low-volume areas often form bell-shaped curves turned on their side, and are commonly referred to as volume profiles.

Figure 1 shows an example of the profile made on a 30-minute bar chart with the VAP indicator configured to group each daily session. I am using X_STUDY 7.8, which we just released. This version has the ability to display the volume labels at each price, as in Figure 1 below.

Figure 1: June 2013 S&P E-mini contract with daily VAP groups.
In evaluating volume profiles, one can apply principles similar to Market Profile® theory. VAP can show additional details not found in profile analysis, too. Look at Figure 1 on March 21. There was a single 30-minute bar forming the day’s low. Notice the heavy volume at 1538.50 and 1538.75 compared to the other price levels during this 30-minute period. This is something you could not see with a standard chart or a Market Profile chart.

VAP Calculations

Now on to the calculations that are derived from VAP. One of the most highly used calculations from VAP data is the Volume Weighted Average Price, or VWAP. This calculation sums the results of the volume at each price multiplied by the price, then divides the sum by the total volume over the interval. You can see the formula here.

In Figure 2 below, we add the VWAP to the chart. This red line shows how the VWAP developed through the day. You will often find high-volume trading and good support and resistance at these levels since this value is used as a benchmark at many large trading institutions. 

Figure 2: Daily VWAP added to the chart.

Figure 3 adds the maximum VAP, or Volume Point Of Control (POC), to the chart. This is simply the price that has the highest volume value for the defined group. Notice I called this Volume POC. If you are familiar with Market Profile charts, you know they too have a POC based on Time Price Opportunity (TPO) count. I’ll save these charts for a later blog. 

Figure 3: Maximum VAP, or Volume POC, highlighted in yellow.

The next calculation is going to be a little harder for me to explain without this blog becoming too lengthy, but I’ll give it a try. Value area, or volume value area since these calculations are going to be done on the VAP dataset, is an algorithm that calculates 70 percent of the volume. I rounded up to 70 percent from the original standard deviation worth of volume, which was 68 percent.

The algorithm starts by finding the volume POC, then adds two volume price levels above or two volume price levels below the POC to the value area. We add the group with the largest volume. For example, if the two price levels above the POC add up to 10,000 volume and the two price levels below add up to 9,500 volume, then we add the top two price levels to the value area. The 9,500 will then be compared to the sum of the next two VAP values above the 10,000 group. Again, the larger of the two amounts is added to the value area. The algorithm continues adding volume groups until reaching 70 percent of the volume. 

Figure 4: The value area is highlighted in green.
In X_STUDY, the VAP indicator is highly customizable. For example, if you want to highlight only 50 percent of the volume for the value area calculation, you can simply change it in the VAP indicator properties. If you want to change the grouping for the VAP, you can do that too.

See Figure 5 for a fast-action volume profile chart. This is a two-minute bar chart with VAP group size of 15. We are now grouping or displaying the volume profiles for each 30-minute bar. The chart also displays the daily VWAP and TT CVD® indicators.

Figure 5: A faster VAP indicator setup.

X_STUDY® 7.8.0 Release

This concludes X_STUDY’s extended set of market data points; but wait, there’s more! With the new release of X_STUDY 7.8 on May 8, we have exposed the above additional calculations for each bar to be used by all of the technical indicators.

That’s right, each bar now has a VWAP, maximum VAP, value area high and low along with the open, high, low and close. This revolutionizes all of X_STUDY’s technical indicators. We haven’t changed the formulas for the existing indicators. We are simply exposing these new bar data points, which are a little more intelligent.

For example, a simple moving average is generally calculated on each bar’s closing price. Now X_STUDY users can choose to use the maximum VAP instead of the close for the bar. How about a 50-day VWAP moving average instead of a 50-day closing price average?

How about using the stochastics indicator and defining the high as the value area high, the low as the value area low, and the close as the maximum VAP of the bar? This turns the stochastic indicator into a stochastic indicator based on each bar’s value area instead of the bar’s high and low.

I could go on and on here, but I will stop now. I’ll be showing more features of X_STUDY 7.8 in my next blog. Until then, I hope the above feature sounds interesting and leads you to try our latest release of X_STUDY.

For the past few years, coverage of Mexico in the U.S. media has largely been dominated by stories of violence stemming from the country’s drug cartels. Lately though, the media have increasingly been turning their attention to the story of Mexico’s booming economy, and new president Enrique Peña Nieto’s bold moves to radically reshape it. This robust growth in Mexico looks set to continue for some time, which has led the Financial Times to label Mexico as the “Aztec Tiger.”1

MexDer, the nation’s only futures exchange, has been taking steps to ensure that it grows apace with the nation’s economy by making substantial upgrades to its matching engine, while continuing to make it easier for foreign investors to access the market. As a result of these changes, as of yesterday, April 14, north-to-south routing to MexDer via CME Group’s Globex® platform is available on TT. You can read the details in the news release that we published today.

The Aztec Tiger 

A perfect storm of positive influences is coming together to make Mexico one of the world’s emerging economic powerhouses. Mexico has a young and growing population, low levels of government debt and low inflation. The country is developing into a leading exporter due in part to widespread implementation of new manufacturing processes, but also due to the fact that Mexico has free trade pacts with 44 countries—more than any other nation on earth.

These forces have combined to make Mexico’s economy one of the few bright spots in a global economy still working off the hangover resulting from the credit bubble. Mexico’s economy grew at around four percent in 2012, quadruple the growth rate of Latin America’s largest economy, Brazil.2 The Mexican peso hit a 19-month high against the U.S. dollar in March, and has outpaced 16 other major world currencies over the last month.3

With its growth track record and favorable conditions for growth to continue, a Nomura Equity Research report in July 2012 predicted that Mexico would overtake Brazil to become the largest Latin American economy within the next decade.4 In addition, Standard & Poor’s and Fitch have indicated that in the near future, they are likely to upgrade Mexico’s debt, which is already investment grade.5

A Pact for Mexico, An Open Door for Growth 

Much of the optimism for Mexico’s future can be traced back to its new president, Enrique Peña Nieto. He hails from the Institutional Revolutionary Party (PRI), which ruled Mexico uninterrupted for 71 years and was identified with corruption and inefficient bureaucracy. That being said, President Nieto is quickly making himself known as a risk taker, willing to take on fights in which none of his predecessors seemed willing to engage.

Within two days of his swearing-in last December, Nieto’s PRI signed a “Pact for Mexico”6 with the opposition National Action Party (PAN). This pact outlines 95 proposals to modernize and liberalize Mexico’s economy. Nieto began by taking on the richest man in the world, Carlos Slim, by announcing plans to foster competition in the telecommunication and television industries, which are currently dominated by monopolies. Later this year, Nieto is expected to propose his most significant change, opening up Mexico’s energy market and allowing the state-run oil concern Pemex to work with the world’s largest oil companies. It’s expected that these reforms, once enacted, will increase Mexico’s GDP growth from four percent to six percent a year.7

Making MoNeT 

In parallel, MexDer and the Mexican government have done quite a bit to attract foreign investors, and to make it easy for them to access the market. Perhaps one of the most significant changes has been the development of the MoNeT matching engine, which went live on Bolsa Mexicana de Valores (BMV), the equities segment, last fall.

The MoNeT matching engine was designed to attract high-frequency traders, mainly from the U.S. and Europe. It boasts internal latencies of 90 microseconds, which is faster than the 110 microseconds of NASDAQ or 125 microseconds at the London Stock Exchange.8 BMV volumes have increased 30 percent to 40 percent since the launch of the new matching engine.9

For international traders and investors, accessing MexDer is straightforward. The north-to-south routing available via CME Globex allows any TT customer with an existing CME infrastructure to route orders to MexDer’s matching engine. MexDer is also accessible now in TT’s MultiBroker environment, which is currently available in beta. Additional information regarding how CME users can access MexDer is posted on the CME website.

There are a number of other reasons why doing business in Mexico is easier than most other Latin American countries. Unlike Brazil, there is no withholding tax of any kind on foreign investment. The Mexican peso is a freely traded and easily convertible currency, and MexDer’s clearing house, Asigna, accepts U.S. dollar-denominated collateral.

La Oportunidad Está En Todas Partes 

Owing to the fact that the U.S. does $1.5 billion per day in trade with Mexico,10 the Mexican markets are, predictably, highly correlated with America’s. North-to-south customers trading MexDer via Globex have access to a number of financial futures that allow for arbitrage opportunities against their American counterparts.

MexDer lists the IPC index of the BMV, which in general tracks closely to the S&P 500. The full Mexican yield curve is available on MexDer, from one-month bills to 30-year bonds, and it converges with the U.S. yield curve. Finally, MexDer lists a Mexican peso/U.S. dollar FX future, one of the 20 biggest FX futures contracts in the world by volume, which sets up arbitrage opportunities with the CME’s equally liquid peso/U.S. dollar future. In a recent MarketsWiki interview, MexDer CEO Jorge Alegria indicated that going forward, the exchange would likely look to list commodity futures linked to similar contracts listed on CME Group. 

The ascent of the Aztec Tiger is no sure thing. There is always the danger of President Nieto’s PRI party losing its appetite for reform and returning to its old ways. There’s the chance that the hiccups in the U.S. economic recovery may impact Mexico, given that 30 percent of the Mexican economy is tied to U.S. exports. There may even be signs that Mexico’s economy is stalling already, which led the central bank to reduce interest rates for the first time since March 2009. Either way, TT users now have the ability to participate in one of today’s most interesting markets.

Thomson, Adam. “Mexico: Aztec tiger.” Financial Times. January 30, 2013.
Rathbone, John-Paul. “Mexico’s reform plan lifts hopes for greater prosperity.” Financial Times. March 20, 2013
Kwan Yuk, Pan. “Mexican peso hits 19 month high”. Financial Times. March 14, 2013. 
“Mexico could pass Brazil as top LatAm economy in 10 years-Nomura.” Reuters. August 8, 2012.
Bases, Daniel. “S&P revises Mexico sovereign credit outlook to positive.” March 12, 2013 
“With a little help from my friends.” The Economist. December 8, 2012.
Thomson, Adam. “Mexico: next stop, a rating upgrade?” Financial Times. March 12, 2013.
Thomson, Adam. “Homegrown software fuels Mexican exchange’s efficiency.” Financial Times. October 3, 2012.
Kledaris, George. “Down Mexico way.” Advanced Trading. February 26, 2013.
10 Friedman, Thomas. “How Mexico got back in the game.” New York Times. February 23, 2013.