1. Hedge Tournament Welcome to the 16th McIntire Hedge Tournament Rules of the Tournament Official source – Do not print! (c) 2002-2015 Stefano Grazioli & Bill Wilhelm

2. Learning Goals Help you learn broad & valuable skills that will help you in your career  How to use IT to solve business problems  Thinking algorithmically  Accessing enterprise data  Mastering Excel automation  Design and implement financial strategies  Hedging  It is a great story to tell recruiters.

3. Logistics  When? Apr 23th, 5:00pm-9:00pm (possible delays).  Where? McIntire Financial Labs (reserved).  Who? Teams of 1-3 (max)  Why? It substitutes for the final Winners will get an A+

4. Options (Grads)  I assume that you are in option #1 until you tell me differently in writing.  Option choices are final. Only declared teams can do team submissions. Options Learning benefitsGradingLogistics #1 Participate in the HT in your current 3 person team Acquire high competence in Excel, SQL & Finance by participating in the Tournament. Unique & exceptional learning experience. Up to A+Recommended #2 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 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.

5. Teams (4230 & GCOMM7770)  Three people max  Lone Wolves  Team Composition is due as soon as you want to do team submissions (after the break)

6. No Team?  Name  Year, School  Tournament attitude / team formation

7. Team Declaration  Email to Grazioli@virginia.edu names, userIds and team nameGrazioli@virginia.edu We are team “Meltdown”: fhe6h, Mark Delltrop has7b, Mary Lund kwu92, Xiao Lee  Check on Collab for your TeamID  Submission MUST be named as in this example: “Team23.zip” or the TA will not know it is a team submission and you will not get a grade.

8. Outline  Tournament Objectives  Trading  Accounting  Technology  Recommendations  Bookmasters: Read the hidden slides!

9. 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 portfolio. The portfolio and a capital account is given to you at the beginning of the tournament.

10. Securities in the Tournament  A dozen Stocks  About 240 European options (n stocks x 2 types x 2 expirations x 5 strike prices)

11. List of Stocks  KMB  GOOG  BABA  SHLD  CMG  AMZN  SNE  DIS  AAPL  VFC  BAC  UA

12. Your Initial Portfolio (IP)  Stock and options on the companies included in the Tournament + Capital account (cash) ~ $50mil.  You cannot change your positions on the tickers/symbols in your IP. That means that you cannot trade the symbols in IP. However, you must cash / pay IP dividends, and may exercise IP options as appropriate.

13. Hedge Tournament WINNING THE TORNAMENT

14. Objective: Minimize risk while producing a target rate of return. Your job is top 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 – TPVif TaTPV > TPV (i.e., loss) TE = |TaTPV – TPV|/4if TaTPV < TPV (i.e., gain) Every Sunday we measure your TE. The Total Tracking Error TTE is the sum of all TEs.

15. Total Portfolio Value TPV = Capital Account + Sum of (Sec. Value * Sec. Quantity)

16. Target Portfolio Value  TaTPV t = TPV atStart * e rt  r = risk free rate  t = time in years from the start of HT

17. Tournament Winners The team who at the end of the trading period has the lowest Total Tracking Error wins the Tournament Section winners

18. 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.

19. Hedge Tournament TRADING

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

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

22. 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

23. Types of Transaction Buy Sell SellShort CashDiv X-Put X-Call  Only these six transaction codes are valid.  Copy exact spelling, including dashes, caps and spaces.

24. 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. Type of Trade EXAMPLE Cost Coefficient (Find them in the DB) Sell Short Stock0.0250 Buy Options0.0100

25. Hedge Tournament End of part I WINIT and Demo

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

27. 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 Trade

28. 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.

29. 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 * (e rt -1) Time is measured in years. CashPositionAfterTransaction Margins = Value of every short position that you own, assessed at mtm. TimeStamp, RowId, Processed. Used by the system. Do not attempt to fill/change.

30. What To Trade? Main job of the portfolio manager in each team:  Identify a good financial strategy  Basics will be covered in class – most will be your own ideas about financial strategy  DELTA HEDGING + your mods is highly recommended

31. Hedge Tournament ACCOUNTING

32. Bookkeeping  Maintain at all times an updated book of positions (“team portfolio”) on the server.  Portfolio update is done immediately after each trade. SYMBOLUNITS MSFT200 IBM100 GE500 CapitalAccount5,000.00 TeamPortfolio03 Exception: “Capital Account” is in $

33. Mark-to-Market Value  Mark-to-Market Value = (Bid + Ask) / 2  Ask > Bid. Difference is the ‘spread’ (0.1-0.2%)  Bid and Ask change in time. Use the latest available.

34. Pricing Models  Options are priced approximately according to the BS formulas  P put = BS (X, S, t, vol, r) +   X = strike price  S = underlier price  t = time in years  vol = volatility  r = risk free rate   = random error (noise) E   Everything except the volatilities is given to you in the data feeds.

35. 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!

36. 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 options that have a price of $0.  For short calls & long put need to have the stock in hand  There will be no short options that expire in the IPs

37. Interest  Cash earns interest continuously  Just before every transaction compute the interest on the Capital Account  Interest = CAccount * e rt -1 where t = time in years between the last transaction and this transaction. r= risk-free interest rate.

38. Margins  You must maintain cash margins = 30% of the current value of all short securities in your portfolio  Margins change in time. Margins are reassessed after each trade  Margins are capped (e.g., MaxMargins =$10mil).  Step by step: Calculate z =  (qty i * 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

39. 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 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 sign

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

41. DataBase Structure Data Feeds Markets Economic Environment Conditions Transactions Bookkeping

42. DataBase Structure (spr 13)

43. Hedge Tournament RECOMMENDATIONS

44. Team Roles You are a small Hedge Fund  Portfolio Manager  CIO/CTO  Bookmaster/COO  PM  Trader  Internal Auditor

45. 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 or amount of work).  You are your own customer – I am here to help you, not judge you.  Have a plan B (and C) 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. Version control.  Test, test, test, test.

46. 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 (disqualification)

47. 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) each  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 a full simulation of the tournament.  General System Test (participation)

48. 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  Use the discussion forum on Collab  If in doubt, ask! Recently edited slide

49. Constants  Trading days / year = 252  Year = 365.25

50. And the Winner is…. Your face here.