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Balanced Basket

Published in Automated Trader Magazine Issue 22 Q3 2011

Execution algorithms have to work hard enough when they only have to reference one market. In this issue's Anatomy of an Algo, Nitin Gambhir, CEO at Tethys Technology, takes things to the next level by describing the operation of a multifactor algo used for one security (crude oil) in a futures basket trade where individual execution rates were constrained by an execution deviation limit. Oh, and as if that wasn't enough, the trade was executed on one of the most volatile days in the crude market this year.

Nitin Gambhir

Nitin Gambhir

The Scenario: It is pre trading hours on June 15th 2011 and a large Chicago-based CTA that operates relative value trading models across US futures markets has received a trading signal overnight for a futures basket on behalf of several managed accounts.

The basket comprises NYMEX Crude, ICE Coffee, CME Lumber, NYMEX Silver, NYMEX Palladium, CBOT 10 Year, CBOT Soybean, KCB Wheat, ICE Cocoa and NYMEX Heating Oil. The trade timeline is from 8.00 AM to 3.15 PM (all times in U.S. EST). Certain contracts will finish earlier if their primary session closes before 3:15.

The trade for NYMEX Crude is a sell order for 8,520 contracts of the July 2011 expiration that must be completed within the context of the basket's risk constraint of balanced execution with a maximum 3% deviation in percentage execution.

The Asset: NYMEX Crude Oil July 2011 expiration.

The Challenge: To sell 8,520 contracts of NYMEX Crude Oil July 2011. The user benchmark to be used is VWAP and all orders will be market orders with a maximum volume participation constraint.

The Trader: The trader heads the CTA's trading desk and handles all energy complex orders. He opts for a multifactor sensitive algorithm specifically intended for futures with which to execute the crude trade.

The Algo: The algorithm is a multifactor sensitive algorithm for futures that looks at factors that contribute to execution cost (including Liquidity, Bid-Ask Spread, and Volatility) and applies appropriate weights to the factors for a specific futures contract. The algorithm uses a dynamic execution profile and adjusts for expected volatility, liquidity and spread over the specified trading period to achieve execution superior to VWAP. The algorithm is recommended for trades with low alpha decay, or uncertain volatility or volume profile.

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