Welcome to the 18th McIntire Hedge Tournament Rules of the Tournament March 2nd, 2017 Official source – Do not print! (c) 2002-2017 Stefano Grazioli & Bill Wilhelm

Hedging Tournament You 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 illiquid portfolio.

Learning Goals Help you learn broad & valuable skills in how to use IT to solve business problems Thinking algorithmically Accessing enterprise data (SQL, ADO, PIVOT) Mastering Excel automation (VB, VBA, VS) Design and implement financial strategies (Hedging) It is a great story to tell recruiters and bosses.

Logistics When? See the class schedule Where? McIntire Financial Labs (reserved). Who? Teams of 1-3 (max.) Why? It substitutes for the final Winners will get an A+

Grading Options Option 1. Participate in the HT Learning benefits Grading Logistics 1. Participate in the HT 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. I assume that you are in option #1 until you tell me differently in writing by March 31st Option choices are final. There is no minimum guaranteed grade.

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

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

Team Declaration Email to Grazioli@virginia.edu We are team “Meltdown”: fhe6h, Mark Delltrop has7b, Mary Lund kwu92, Xiao Lee You will be given a teamID

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 SBUX BRKA RGR ATVI NFLX BABA TEVA NKE XOM AAPL ATT COST

Your Initial Positions (IP) Stock and options on the companies included in the Tournament Initial Positions are illiquid. You cannot change your net position 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 at mtm + Total value of your AP at mtm+ Capital account Mtm = Mark to market = (bid + ask) / 2

WINNING THE TORNAMENT

Target Portfolio Value (TaTPV) TPV (unm.) TaTPV TPV Target Total Portfolio Value (TaTPV) Total Portfolio Value (TPV) Total Portfolio Value (TPV) unmanaged Time HT Starts HT Ends TaTPVt = TPVatStart * ert r = risk free rate t = 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. D

TRADING

Basic Architecture Initial positions, Market prices, Risk free rate… Fin. Data Feeds Fin. Info Positions Initial positions, Market prices, Risk free rate… Your team Trades Updated Positions

Trade Execution Trades are executed by posting a trade record to the ‘transaction queue’ Trades are irrevocable

Types of Trades Transaction 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 cost = Cost Coefficient * (Qty * price) Transaction Costs 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.

Transactions and Trades YOU Confirmation Ticket (next “day”, i.e. next minute) Transaction (trade) SYSTEM

Tournament Timeline Trading ~ 3 hrs Start End Market data & IP posted (neither is fully known in advance) The tournament begins Second set of market prices Tournament ends First set of market prices Third set of market prices... Trading ~ 3 hrs No Trade No Trade Start End All times are server times

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.

Data Dictionary for Transactions Date = the current date found in the environment variables TeamId = official team number found in Collab Type = one of the six transaction types. Must be spelled exactly. Symbol = the symbol of the transacted security. For X-put and X-call it is the option, NOT the stock. Price = the appropriate bid/ask. For CashDiv, Dividend is the actual dividend in $ per share. Cost = the cost of the transaction. Price * qty * t.c. coefficient Tot value = qty * price +/- Cost of the transaction InterestSinceLastTransaction = Interest on the cash held since last transaction (or beginning of the tournament if none exists). Computed as CAccount * (ert -1) Time is measured in years. Margin = Value of every short position that you own, assessed at mtm. TimeStamp, RowId, Processed. Used by the system. Do not attempt to fill/change.

What To Trade? Main job of the portfolio manager in each team: DELTA HEDGING + your mods is highly recommended Basics will be covered in class – add your own ideas about financial strategy Sophisticated strategies (e.g., Gamma) will be also covered but not implemented

ACCOUNTING

Bookkeeping Maintain at all times an updated book of positions (“team portfolio”) on the server. Portfolio update is done immediately after each trade.

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 The owner of the stock at the beginning of the dividend day gets the dividends Must cash them (if long)/pay them out (if short): use “CashDiv” on the dividend date 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 where t = 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 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 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 quantity sign.

TECHNOLOGY The tournament will run in HedgeTournamentALPHA on f-sg6m-s4.comm.virginia.edu

DataBase Structure (datamodel)

RECOMMENDATIONS

Team Roles You 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, nor amount of work). You are your own customer – I am here to help you, not judge you. Have a plan B 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. Make copies. Version control. Test, test, test, test. Full simulations. Not the first 30 minutes.

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 (most severe)

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 full simulations of the tournament.

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 If in doubt, ask! Recently edited slide

Constants Trading days / year = 252 Year = 365.25

And the Winner is…. Your face here.