7.1 / 25 - Managed Futures

Question 1

LO 25.1: Demonstrate knowledge of the structure of the managed futures industry.

Answer 1

• Discuss the structure and key features of the managed futures industry

Question 2

What does the term managed futures describe?

Answer 2

investing in futures and similar derivatives through professional money managers or commodity trading advisers (CTAs).

Question 3

commodity pool

Answer 3

• a futures trading fund
• managed by a CPO (Commodity Pool Operator)
• CTAs are investment management firms that trade directly for (U.S.) investors in commodity and financial futures or options.
• CPOs are public or private investment trusts or syndicates that combine investor capital into a commodity pool, such as a fund or limited partnership, which are then allocated to individual CTAs or are directly invested in futures contracts.

Question 4

Commodity Futures Trading Commission (CFTC)

Answer 4

• created in 1974 - Federal agency that regulates all futures and derivatives trading
• intended to provide gov’nt oversight of managed futures trading industry
• Partners with the NFA

Question 5

National Futures Association (NFA)

Answer 5

• established in 1982
• independent self-regulated organization, with primary responsibility to audit member firms and individuals conducting futures trading for the public.
• Managed futures managers are considered Alternative Investment Fund Managers (AIFMs) in Europe and are regulated by the Alternative Investment Fund Managers Directive (AIFMD). Doing business in Europe requires registration as an AIFM and compliance with specific regulations and reporting requirements.

Question 6

What is a primary driver of increase in managed futures industry from the early 2000s?

Answer 6

• increased from under $50bb in early 2000s to over $300 bb in 2011-2013 period.
• Greater standardization of OTC products (related to increased oversight since 2008) has hapened in US and Europe, transition of bilateral OTC contracts to multilateral cleared contracts that are characteristic of futures

Question 7

LO 25.2: Demonstrate knowledge of four core dimensions of managed futures investment strategies.

Answer 7

• Discuss and compare managed futures strategies defined by the core dimension of data sources.
• Discuss and compare managed futures strategies defined by the core dimension of implementation styles.
• Discuss and compare managed futures strategies defined by the core dimension of implementation strategy focus.
• Discuss and compare managed futures strategies defined by the core dimension of time horizons.

Question 8

What are the four core dimensions of managed futures

Answer 8

1. data sources
2. implementation style,
3. strategy focus
4. time horizon

Question 9

Data Sources: Fundamental or technical strategies

Answer 9

• *• Fundamental strategies** use future-oriented information including economic forecasts and supply and demand estimates, for example.
• *• Technical strategies** focus on historical price and trading volume information, for example.

Question 10

Implementation Styles: Systematic or Discressionary strategies

Answer 10

• Systematic Strategies - primary quant modeling in decisionmaking as to when to purchase or sell, position size, with little input from managers. True quant fund style; some positions may only be held for seconds. Complexity of these strategies has incrsased with increased relaince on trading and technical support.
• Discretionary Strategies - generally less diversified than systematic strats. managed exclusively by the CTA manager in an attempt to take advantage of perceived pricing opportunities.
  
  • a significant number of discretionary strategies integrate quantitative models in determining positions, so the distinction between systematic and discretionary strategies is not always clear.

Question 11

Strategy Focus: Momentum Strategies (one of several most common)

Answer 11

• Momentum Strategies - rely on the basic principle of “buy winners and sell losers.” Momentum is the rate of acceleration of a security’s price changes. Therefore, if a security’s price has momentum, then its price should continue in the same direction for the foreseeable future. this strategy attempts to profit by using a trend-following strategy that takes long positions on assets with upward moving prices and short positions on assets with downward moving prices. This concept is known as time-series momentum.
  
  • Moving average strategies - can be as simple as an indication to take a long position when the current price is above the moving average. A moving average crossover strategy combines moving averages from various time periods together with crossover rules so as to conclude when to take a long or a short position (e.g. if 30 day moving average moves above 90 day).
  • Breakout strategies - provide a trend signal once the price moves away from a specific range with the resistance level being the highest price and the support level being hte lowest price for a given period. A trailing stop indicates a position should be exited if the price falls below a certain amount under the most recent high price.
• ​

Question 12

Strategy Focus: Global Macro Strategy

Answer 12

• ​Use fundamental analysis to decide on long or short positions in equities, fixed income, forex, and commodities.

Question 13

Strategy Focus: Relative value strategies

Answer 13

• Relative value strategies attempt to spot mispricing opportunities between markets or over time. An example would be a calendar spread where long (perceived underpricing) and short (perceived overpricing) positions are taken on futures contracts of varying maturities. Another example could involve taking a position on an asset and a position on a corresponding derivative of that asset.

Question 14

Mean-reversion and countertrend strategies

Answer 14

• Mean-reversion and countertrend strategies assume mean reversion of prices in the immediate future. Implementation times range from several days or weeks for mean reversion and countertrend to several months for trend following. A contrarian strategy attempts to trade opposite to the market trend, and so mean-reversion strategies could be contrarian. In contrast, a trend-following strategy trades based on the market trend.

Question 15

Carry strategies

Answer 15

• Carry strategies attempt to profit from differences in the net benefits or costs of holding commodities. Commodities usually have negative carry (return) due to storage costs, but if they are in short supply or high demand, then a strategy involving shorting futures contracts on those commodities may result in positive carry.

Question 16

Multistrategy CTAs

Answer 16

• Multistrategy CTAs bring together several strategies to allow for sufficient diversification

Question 17

Time Horizon Strategies

Answer 17

• *• High-frequency trading strategies** involve trades that are executed in milliseconds and do not explicitly consider price trends. Transaction costs occur on every trade, so they are very relevant to consider for both high-frequency and short-term trading strategies.
• *• Short-term trading strategies** range from intraday to a month, and the average holding period is slightly under 10 days. Mean reversion and countertrend strategies usually fall in this category. Trading capacity may be an issue when a strategy is contemplating a significant buy or sell transaction in the short term. The end result may be that the transaction causes the market to move against the strategy (i.e., a significant buy transaction at a low price now may cause a price increase that results in future buy transactions to be much costlier for the strategy).
• *• Medium-term trading strategies** range from one to six months. Because trading adjustments are not as frequent or rapid for medium-term and long-term strategies, transactions costs are less of a concern.
• *• Long-term trading strategies** are for more than six months.

Question 18

LO 25.3: Demonstrate knowledge of the foundations of managed futures.

Answer 18

• Describe the adaptive markets hypothesis (AMH).
• List and describe four practical implications of the AMH.
• Discuss the topics of divergence, dislocation, and momentum with regard to markets and the AMH.
• Discuss how market divergence may be measured and calculate signal-to-noise ratio (SNRt) for a given price series and the market divergence index (MDI) for a given signal observation period.
• Define crisis alpha opportunities, and describe characteristics of systematic trend following strategies and their implications during periods of equity

Question 19

Adaptive Markets Hypothesis

Answer 19

• used to describe market behavior within the context of managed futures strategies (instead of efficient markets hypothesis).
• The AMH states that when greater resources are available and there is less competition, more opportunities to profit will be available. When there is more competition, then those investors with a competitive advantage will adapt and continue to earn profits. Those who are unable to adapt will suffer losses and exit the market, thereby lessening the competition.

Question 20

Four Practical Implications of the Adaptive Markets Hypothesis (AMH)

Answer 20

1. risk-return relationship (risk premium) will change with time. this is predictible with technical and fundamental analysis - dynamc asset allocation methods could profit form those changes
2. Market Efficiency is relative in nature, should be viewed as a continuum ranging from inefficient to efficient. Different levels will present based on time and investor. There could be occasional periods where marketn inneficiency strategies could be effective
3. Adaptation is required in investment strategies to deal with changnig mkt conditions. Opportunities arise and dissipate in time.
4. Alpha will become beta over time due to competition and better analytical techniques. Stable and consistent sources of alpha do not exist but occasional sources of alpha do exist. The latter provide chances for profits to be earned using adaptive strategies.

Question 21

What is Divergence?

Answer 21

Divergence can be thought of as the evolution of the market due to economic changes (e.g., supply and demand shifts; shift in risk tolerance, supply, or demand; behavioral biases). In context of the AMH, the economic changes will lead to increased competition in the marketplace, shocks in the market, and the movement to a new equilibrium level.

Question 22

What is Dislocation?

Answer 22

Dislocation simply refers to prices changing from the no-arbitrage to new equilibrium levels as described above and is caused by gradual or extended episodes of market divergence.

Question 23

In the context of the AMH, momentum

Answer 23

In the context of the AMH, momentum also is caused by gradual or extended episodes of market divergence. As discussed earlier, momentum refers to the movement of security prices in a particular direction for a continuous time period into the future.

Question 24

Signal to Noice Ration (SNR)

Answer 24

Using historical data, market divergence can be measured using the signal-to-noise ratio. The signal-to-noise ratio (SNR) is the ratio of the overall trend to a series of price changes during the same period, or the ratio of the magnitude of the trend to the volatility around that trend.

Question 25

What is the signal observation period

Answer 25

This is the lookback period for signal to noise observations, generally based on 100 days when medium or long-term trend analysis.

Question 26

market divergence index (MDI),

Answer 26

Using SNR for individual markets as a departure point, now think about total level of divergence in the markets invested within the portfolio.

• THe MDI is the average of the relevant SNRs fora given observation period (n) and number of markets (M). The greater the MDI, the greater the trends are across markets in a portfolio. Equation:

Question 27

LO 25.4: Demonstrate knowledge of the benefits of commodity trading advisors (CTAs).

Answer 27

• Discuss the conclusions of academic research regarding the benefits of CTAs.
• Describe the sources of returns for CTAs.
• List and describe eight positive risk-return trade-offs that CTAs provide for their investors.

Question 28

Crisis Alpha

Answer 28

Crisis alpha opportunities occur during a market crisis when most investors do the same thing, resulting in a market trend. Certain adaptable investors are able to capitalize on such opportunities. For example, an adaptable investor may pursue a very liquid and flexible investment strategy that consists solely in futures and faces little credit risk.

Question 29

Four Core Decisions of a Futures Trading System

Answer 29

1. Entry. When should a position be taken?
2. Size. What is the appropriate size for the position?
3. Exit. When should the investor unwind the position?
4. Allocation. What is the appropriate risk or capital to allocate to various sectors and markets?

Question 30

volatility targeting (Futures Sizing method)

Answer 30

Market volatility will impact the size of a position taken, and volatility targeting is one method used to determine the size as follows:

Question 31

The point value (or contract size)

Answer 31

the gain or loss in the contract from a one-point change (e.g., $1) in futures prices.

Question 32

Three Common Methods of Risk Allocation: (Manged Futures)

Answer 32

1. Equal dollar risk allocation. The same dollar amount is invested in each market, and there is no regard for any correlation between markets

2. Equal risk contribution. This considers the risk contribution of markets and considers correlation between markets

3. Market capacity weighting. This depends on individual market capacity, or market size, based on daily trading volume and price volatility.

Question 33

Managed Futures strategies can earn posititve returns in exchange for providing the following services to the market:

Answer 33

• Giving market participants an opportunity to reduce risk by taking the opposite position and allowing them to hedge.
• Offering liquidity to market participants who desire it.

• Assisting market participants with their rebalancing needs by taking offsetting positions.

Question 34

Positive Risk Return Tradeoffs Provided by CTAs

Answer 34

1. Diversification
2. Performance
3. Access to Multiple Markets
4. Transparency
5. Liquidity
6. Size
7. No withholding taxes
8. Low Foregin exchange Risk

Question 35

LO 25.5: Demonstrate knowledge of systematic futures portfolio construction.

Answer 35

• Recognize the four core decisions of a futures trading system.
• Describe the use of data processing in futures portfolio construction.
• Describe approaches to position sizing in futures portfolio construction, and calculate the number of futures contracts in a given allocation.
• Describe the process of market allocation in managed futures portfolio construction.
• Summarize the role of trading execution in a managed futures portfolio construction.