Contents - Index

Stock Index Futures:  Trading/Hedging Project
©2009 OS Financial Trading System


Introduction

This is a small group project designed around the FTS Real Time Client's Stock Index Futures cases.  It is designed to be completed in small teams.  Grading is based on both form of presentation and content.

The project has two phases and it is designed around the US stock index futures markets using the FTS Real Time Position Manager for implementation purposes.  The two phases are:

In Phase I your objective is to learn how to apply the cost of carry model, for arbitrage free futures pricing, to stock index futures defined on the S&P 500 index and the Nasdaq 100 index.  In addition, you are required to trade upon your assessment of the price of these futures contracts relative to current market prices.  The available futures markets are E-Mini futures markets defined on the S&P500 and Nasdaq100 for two different maturities and Eurodollar futures markets.  The latter will provide you access to current information on financial carry costs plus the ability to trade the financial cost of carry.  

In the trading component of phase I your objective is to apply your assessment of the intrinsic value of the stock index futures' contracts to exploit relative pricing differences that you assess are available in the market.  That is, your trading is not based upon your view of whether the general market is going up or down but rather your assessment of relative price differences that are predicted from your implementation of the arbitrage free pricing theory.  For this exercise you can trade both the E-Mini Index futures 

In Phase II you will apply your Phase I knowledge to a risk management problem using the FTS Real Time Position Manager.  All teams face the same hedging problem and will implement their strategy over the same period of time in competition with each other.  Positions will be marked to market at a sequence of times over the hedging period and hedging performance will be evaluated relative to these times on a risk return basis.  In this phase two additional securities will be added to the project.  These are the relevant Exchange Traded Funds (SPY and QQQQ).  Real world basis risk is introduced into this exercise because the future is defined on the index whereas the ETF is a proxy for the actual index (i.e., it is designed to track the index).  Your objective in phase II is to design and implement a replicating position of the non tradable position to manage the market risk associated with this position.  

Note:  Before starting phase II all positions should be reset to constant starting values.  The moderator should contact FTS (at least 24-hours notice) to have positions reset.

Trading Objective:   Each team's trading/hedging performance in phase II is measured using the Sharpe ratio.  The FTS System automatically computes this ratio for you you Each team will be ranked over the duration of phase II using the Sharpe ratio this will determine your final performance ranking.

Background Information Relevant to the Cost of Carry Model

Extensive dividend information for the underlying index is available from 

<http://www.indexarb.com/dividendAnalysis.html>


This is useful information for computing the theoretical price of the futures contract.  


<http://www.bloomberg.com/markets/rates/index.html>

<http://online.wsj.com/mdc/public/page/2_3020-moneyrate.html?mod=topnav_2_3000>

<http://www.federalreserve.gov/Releases/H15/update/>


In addition you will have access to real time information from the Eurodollar futures markets plus historical return information for the ETF's and the underlying stock indexes.

Important Due Dates:

Phase I:  Due Date on or before ----- in either MS Word or pdf file format.

Phase II:  Due Date on or before ______ in either a MS Word or pdf format.

Your assigned team number and each member of the team's name should be displayed clearly on the coversheet.

Required: 

All projects should contain a cover sheet that lists the full name of each team member. 

Phase I: There are three parts to your phase I report. 

Part A:   An Executive Summary (this is a summary not exceeding 1-page), 

Part B:   A write-up of the details associated with how your team applies the cost of carry model to price both the S&P 500 and Nasdaq 100 futures. That is, suppose you are an analyst who must communicate to either a programmer who is programming your implementation strategy, or traders on your trading desk who are applying the cost of carry model to two futures markets. You should also highlight important differences between applying the cost of carry model to each stock index futures market. 

Part C:   Given your answer to part B, now design a simple trading strategy around your implementation of the cost of carry model that attempts to "buy low and sell high." You should apply this strategy over some short period of time (relevant to your strategy) using the FTS real time position manager. Describe your trading strategy and analyze it's trading performance. Based upon this application provide some brief conclusions regarding your assessment of the efficiency of the futures markets over the time period you traded. You should make use of the FTS real time position manager's reports to answer part C. 

Your team's project write-up should not exceed 5-pages plus any appendix material you choose to add. That is, your Executive Summary is 1-page and parts B and C should not exceed 4-pages combined. You can provide additional details in appendices if you want to. Finally, your report should be logically organized including a brief description of important assumptions, measurement 


Phase II:    In this phase you will apply the knowledge you have gained from phase I to implement a risk management hedge in competition with the other teams over a common fixed period of time as specified by your instructor. 

Each team's position is reset to at the beginning of this phase to a position worth around $USD1Million. The position will consist of a non tradable position in the two ETF securities (SPY and QQQQ) plus cash. You will be able to trade in the futures market to manage risk. 

Price Note:   All settlements in trading are at the real time real world price. The ticker prices displayed on the screen are indicative prices only as no real time prices are transmitted.  However, traders using the FTS real time position manager can access free real time quotes for the ETF's from the major financial sites using the built in browser and the internet. 

Recall, the FTS system will automatically mark-to-market every team's hedged position every day over this period of time.   Your trading/hedging performance will be judged using the Sharpe Ratio.  This is available to each trader by clicking on the menu item Reports, then select Get Trading History and Reports, and finally select Performance Reports from the dropdown menu containing the list of reports that you can automatically access.  

Required Phase II: There are three parts to your phase II report. 

Part A:    An Executive Summary not exceeding 1-page, 

Part B:    The operational details associated with your hedging strategy including the operational details with respect to how you implemented the strategy (e.g., static, dynamic and how basis risk was handled). 

Part C:   You should provide a short discussion of the following issue: 

Critically evaluate your hedging strategy including an assessment of the strengths and weaknesses of your strategy in the light of your performance relative to other teams. 

Your report should not exceed 5-pages plus any appendix material you deem to be necessary. That is, your Executive Summary is 1-page and parts B and C should not exceed 4-pages combined. You can provide additional details in appendices if you want to. Finally, your report should be logically organized and laid out clearly as it will be graded on both the form and content of the presentation.