Download Performance Measurement

Topic 9
©Schwartz, Sipress, Weber
Fall 2008
Slide 1
Performance Measurement in
Trading
1. Beyond P&L
2. Risk measures in trading
3. Transactions cost analysis (TCA)
• Useful for How to trade-Where to tradeWhen to trade decisions
• Role of Alternative trading systems (ATS)
• Achieving Best Execution
©Schwartz, Sipress, Weber
Fall 2008
Slide 2
Measures
1. Profits (P&L)
2. Trading “surplus” vs. target price
3. Benchmarks (VWAP, TWAP, …)
©Schwartz, Sipress, Weber
Fall 2008
Slide 3
Transaction Cost Analysis (TCA)
See SFW text: Pages 327 - 331
©Schwartz, Sipress, Weber
Fall 2008
Slide 4
Risk Management
1. Operational and Transfer Risk
• Technical and human failure
2. Counterparty Risk
• Who is your trading counterparty?
• A Central Counterparty (CCP)
3. Market Risk
• Volatility
• Pages 332 – 337
©Schwartz, Sipress, Weber
Fall 2008
Slide 5
Best Execution
Text: Pages 337 - 345
©Schwartz, Sipress, Weber
Fall 2008
Slide 6
Performance Measures: P&L
•
•
The principal-proprietary trader case
Unrealised mark-to-market (9:41-9:55 a.m.):
Profit = 20,000  (Bid – 60.00)
•
Partially realised … after position closing trade:
Profit = 8,000(0.10) + 12,000(Bid – 60.00)
•
Fully realised:
Profit = 8,000(0.10) + 12,000(0.05) = $1,400
•
Do we need to risk-adjust our $1,400 ?? – YES!
©Schwartz, Sipress, Weber
Fall 2008
Slide 7
Institutional Trading Costs/TCA
•
•
•
To a retail investor, stock •
exchanges look like
vending machines
Institutional-sized buy or
sell interest overwhelms
the exchange’s trading
structures
Results:
– Institutions avoid active
participation in price
discovery
– Latent demand,
illiquidity, and higher
trading costs
©Schwartz, Sipress, Weber
How do large traders get
needed liquidity?
–
Dealer/block trading desk
capital
–
Place anonymous limit
orders
–
Enter into a crossing/
matching network
–
“Shop” orders and
negotiate
–
Use Not Held (NH) orders
–
Slice, dice, and shred
(Algorithmic trading)
–
Don’t fully implement their
ideas
Fall 2008
Slide 8
Institutional Equities (U.S. Survey)
Annual
Growth
Rate
Percent Traded via Execution Venues (shares)
Crossing
Networks
+19%
Algorithms
+9%
DMA
+10%
Program Desk
+3%
─13%
Sales Desk
0
Source: TABB Group
©Schwartz, Sipress, Weber
10
20
2006
30
40
50
2008
Fall 2008
Slide 9
How Fast to Execute?
Expected shortfall (bps)
80
Expected liquidity impact
Expected base-price move
60
40
Assuming no change in base price:
Minimize liquidity impact by slicingup order and spreading over time
Assuming trader expects base
price to rise over the next
four hours: Pay for liquidity
in market
20
0
0 to 10s
10 to 30s
30 to 1min
1 to 5min
5 to 15min
15 to 30min
30min to
1hour
1 to 2hour
2hour to
4hour
4hour+
Time to execution
©Schwartz, Sipress, Weber
Fall 2008
Slide 10
Hyper-Continuous Market
5 minutes: 1 million shares traded in 1,170 trades averaging 682 shares,
with a price range of 17.10-17.20 (0.6%)
©Schwartz, Sipress, Weber
Fall 2008
Slide 11
Achieving “Best Execution” – Difficulties
•
The CFA Institute Trade Management Guidelines:
“The Trading Process Most Likely to Maximize
the Value of Client Portfolios.”
•
Growing regulatory obligations to demonstrate
• best execution practices
• soft and bundled commissions paid by money
manager are in investors interests
Who’s accountable for trading costs?
•
Bid-ask spread and market/liquidity impact are
exchange and sell-side determined
•
BUT delay and opportunity costs are the responsibility
of the fund manager
•
Poor selection of a broker …
©Schwartz, Sipress, Weber
Fall 2008
Slide 12
Are Trading Commissions for
Trading?
• 95% of US institutional brokers received trading
commissions for research and investment-related
services (SEC, 1998)
• 82% of US buy-side report paying “soft dollars” for
third-party research and investment-related services
(Greenwich Associates, 2004)
• The average US institutional broker kicks back $1 in
products and services to buy-side client for every
$1.60 it receives in trading commissions (Greenwich
Associates, 2004)
©Schwartz, Sipress, Weber
Fall 2008
Slide 13
Risk Measures in Trading
Trading outcomes need to be assessed relative to risk
Performance measurement is not complete without risk
measurement
Risk measures in trading will depend on:
• Trader’s role (prop trading, institutional order handling,
market maker, …)
• Time horizon (intraday, daily, quarterly, …)
• Objective (P&L, minimize transactions cost, timing, …)
©Schwartz, Sipress, Weber
Fall 2008
Slide 14
Market Maker Risk =
Average Absolute Value of Position
Position
POSITION
0
TIME
e.g., first half of day, short 200, second half long 600 =>
Average position = (200+600)/2 = 400
Position size is time-weighted by time it is held
©Schwartz, Sipress, Weber
Fall 2008
Slide 15
Buy-Side Trader Risk =
Average Absolute Value of Gap
Between Position and Pace
1,000
POSITION
500
Position
0
4 pm
9:30
©Schwartz, Sipress, Weber
Fall 2008
TIME
Slide 16
Greater Buy-Side Trader Risk: Larger
Average Gap Between Position & Pace
1,000
POSITION
500
Position
0
4 pm
9:30
©Schwartz, Sipress, Weber
Fall 2008
TIME
Slide 17
Traders 1 & 2 Are Trying To Build
1,000 Share Positions Long & Short
• Trader 1 builds it gradually and has an average gap to the pace position of 40.6.
• Trader 2 waits until the end of the day to sell the last 850 and has an average
deviation
of 248
©Schwartz,
Sipress, Webermore risk
Fall 2008
Slide 18
Our Measure of Buy-Side Trader Risk:
Gap Between Position & Pace
Target shares
(2,000) to acquire
by end of day
Pace = Position if
acquired evenly
over the day
Pace if original
order for 1,000
was not amended
• Fund manager gives an instruction to buy 1,000 by the end of the day
• 12:45 (halfway through the day) fund manager increases the order
©Schwartz, Sipress, Weber
Fall 2008
Slide 19
Risk is Controlled by Staying
Within the Collars (Grey Lines)
Risk increased
and points lost
when outside
the collars
©Schwartz, Sipress, Weber
Risk reduced and
points added for
staying within the
collars
Fall 2008
Slide 20
TraderEx’s Composite Metric
User Total Score
= f(three components)
= f(VWAP, P&L, Risk)
©Schwartz, Sipress, Weber
Fall 2008
Slide 21