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CFA L3 Matheus > Section 5 - R25 - Trade Strategies (Size, Prices, How to) > Flashcards

Section 5 - R25 - Trade Strategies (Size, Prices, How to) Flashcards

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1
Q

Motivations to Trade (List)

A
  1. Profit seeking
  2. Risk management and hedging needs
  3. Cashflow needs
  4. Corporate Actions (reinvestment of dividends, margin posting, index reconstitution, minimize tracking errors)
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2
Q

Trade Input: Order Characteristics (List)

A

a. Side of the Order (long, short). Buy in rising market or sell in a falling puts you in market risk.

b. Size of the Order (large create market impact, take longer to trade)

c. Relative volume (% average daily volume - ADV)

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3
Q

Trade Input: Security Characteristics (List)

A

a. Security Type: Liquidity and Trading Costs vary by exchange

b. Short Term Alpha: Up or Down or Reversion and Time Decay

c. Volatility: affects execution risk (risk of adverse price movement over the trading horizon)

d. ↑ Liquidity = ↓ Execution Risk and ↓ Trading Cost = ↓ Need of Breaking Tranches

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4
Q

Trade Input: Market Conditions (Describe)

A

↑ Volatility = ↑ Execution Risk = ↑ Necessary Trading Horizon but
↑ Volatility = ↑ Trading Urgency

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5
Q

Trade Input: Individual Risk Aversion (Describe)

A

↑ Risk Aversion = ↑ Concern about market risk

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5
Q

Market Impact and Execution Risk (List)

A

1) Temporary Market Impact Cost: temporary, short-lived impact on a security. Ex: Overreaction.

2) Permanent Component of Price Change: Impact of the information of the content. Ex: PETRO e política de preços

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6
Q

Information Leakage Prevention (Describe Strategy)

A

Hide Trades

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7
Q

Velocity of Trades and Implications (Describe)

A

↑ Fast Trade = ↑ Market Impact
↓ Slow Trade = ↑ Execution Risk / ↑ Market Risk

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8
Q

Pre-Trade Reference Prices (List and Describe)

A
  1. Pre-Trade Benchmarks:

a. Decision Price: price @ which the decision to trade was made

b. Previous Close: Used by Quants

c. Opening Price: Used by PMs who trade from the open

d. Arrival Price: Price of the Time the Order was entered. Used by alpha traders. Goal is to transact close to current mkt price

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9
Q

Intraday Bench Reference Prices (List and Describe)

A
  • Used by funds that trade passively over the day, seek liquidity or rebalancing
  • Do not expect the security to exhibit any short-term price momentum
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10
Q

Volume-Weighted Average Price (Concept)

A

Preço médio ponderado considerando (i) volume de cada trade e seu (ii) respectivo preço

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11
Q

Time-Weighted Average Price (Concept)

A

If there were 7 trade prices, (i) take all (ii) sum up and (iii) divide per 7

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12
Q

Post-Trade Benchmarks (Concept)

A
  • Closing price (common for funds valued @ NAV) and buy on close to minimize tracking error
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13
Q

Price-Target Benchmark (Concept)

A
  • Purchase shares at or below some target price
  • Used by PMs seeking short-term alpha
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14
Q

List of Trade Strategies

A
  • Short Term Alpha: high urgency
  • Long Term Alpha: low urgency
  • Risk Rebalance: balance risk exposure
  • Cash Flow Driven (equitization): derivatives to invest new mandate
    a. Client Redemption Trade
    b. New Mandate Trade
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15
Q

Trade Execution Strategies (List)

A
  1. Large Block Trades: Urgent or Non Urgent
  2. Large Orders: Standardized in Order Driven or using DMA (Algorithmic Trading)
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16
Q

Principal and Agency Trades (Differentiate)

A

Principal Trade: Broker assumes all or part of the risk of the order, pricing the risk into the quoted spread

Agency Trade: Broker is only an agent of the client, who absorbs all risks.

17
Q

Large Block Trades: Urgent (Describe)

A
  • Principal Trade
  • Broker risk Trade
  • Dealer is the counterparty
  • Dealer buy or sell from its inventory
  • Wider bid ask spreads
  • Quote-driven, OTC or off-exchange markets
18
Q

Large Block Trades: Non-Urgent (Describe Implementation)

A
  • Agency Trade (broker dealer does NOT absorb risks)
  • Broker attempts a cross against a counterparty
  • Then execute order in the open market and may split it up
19
Q

Liquid, Standardized Securities with Order-Driven (Describe implementation)

A
  • Trade electronically with multiple venues
  • For trades other than large orders
20
Q

What to use if Large Orders if High-Touch is Inefficient (Describe best strategy)

A
  • Use algorithmic trading (DMA)
  • Used if high-touch is inefficient and/or
  • High Touch trades may be subject to front-running
21
Q

Algorithmic Trading (List)

A
  1. Execution
  2. Profit-seeking
  3. Execution Classifications:
    a. Scheduled (POV, VWAP, TWAP)
    b. Liquidity Seeking
    c. Arrival Price
    d. Dark strategy (liquidity aggregators)
22
Q

Execution Algorithms (Describe)

A

The PM decides what to buy and sell on the basis of its INVESTMENT STYLE and INVESTMENT OBJECTIVE and then implement the decision in the market as efficiently as possible.

The algorithm then executes the order by following a set of rules in the specified.

23
Q

Profit Seeking Algorithms (Describe)

A

The ALGO decides what to buy and implements the decision ASAP.

They use real-time price information, market data, volume and volatility to determine.

Mostly used by quants.

24
Q

Execution Algorithm Classifications (List)

A

a. Scheduled: send orders based in the historical volumes or specified time periods.
Types: (a) POV, VWAP, TWAP

b. Liquidity Seeking: Opportunistic. Trade faster when liquidity shows up across multiple venues. Use exchanges, ATS and dark pools.

c. Arrival price: Trade more aggresively @ beggining of the order. Front-loaded strategy. Used when momentum is expected so you want to take advantage of THAT specific moment.

d. Dark Strategies: Use dark venues to avoid information leakage

e. Smart Order Routers: Determines destinations (venues) with highest probability of executing a limit order.

SLAD = Schedule, Liquid, Arrival, Dark, SORs

25
Q

Execution Algorithm: Scheduled (Describe)

A

Send orders based in the historical volumes or specified time periods.

Types:
(a) POV: ↑ Volume = ↑ Trades
(b) VWAP: Follows historical profile of volume trades
(c) TWAP:Equal weighted time schedule (X shares per time period)

26
Q

Execution Algorithm: Scheduled (Appropriateness)

A
  • PM has no expectations of momentum (adverse price moves)
  • PM has ↑ tolerance for longer execution time periods
  • Minimizes market impact
27
Q

Execution Algorithm: Liquidity Seeking (Describe)

A

Opportunistic. Trade faster when liquidity shows up across multiple venues. Use exchanges, ATS and dark pools.

28
Q

Execution Algorithm: Liquidity Seeking (Appropriateness)

A
  • Orders are large
  • There is high trade urgency while avoiding market impact
  • Printing limit orders would reveal info
  • Less liquid trades
29
Q

Execution Algorithm: Arrival Price (Describe)

A
  • Trade aggressively @ beggining of the order
  • Front-loaded strategy
  • Seek to trade close to current market price
  • Used when momentum is expected in prices
30
Q

Execution Algorithm: Arrival Price (Appropriateness)

A
  • PM is risk adverse and wishes to trade quickly to reduce execution risk
  • Security is liquid, order is not out-sized
31
Q

Execution Algorithm: Dark Strategies (Describe)

A
  • Used to avoid any information leakage
  • Order size is large and may have significant market impact
32
Q

Execution Algorithm: Dark Strategy (Appropriateness)

A
  • Used for illiquid securities
  • Wide bid-ask spreads
  • PM does not require full execution (low trade urgency)
33
Q

Execution Algorithm: Smart Order Routers (Describe)

A
  • SOR detemrines destination (venues) with the highest probability of executing a limit order
  • Used with small market or limit orders that will have no market impact
34
Q

Execution Algorithm: Smart Order Routers (Appropriateness)

A
  • Good for orders that trade in multiple markets
  • Used when immediate execution is necessary and there is no info leakage risk
35
Q

Compare Execution Strategies & Usage (List and Describe)

A

1) Scheduled: No momentum expected / OK with long execution period / Minimizes market impact

2) Liquidity: High urgency need / Multiple Venues

3) Arrival Price: Momentum is expected / PM is risk adverse and wants to trade quickly / Security is liquid

4) Dark Strategies: Illiquid security / Wide bid-ask / PM does not require full execution

5) SOR: OK for low market impact / Securities traded on multiple markets

36
Q

Comparison of Markets (List)

A

1) Equities: Exchanges and dark pools, most trades are electronic

2) Fixed Income: OTC, Quote-driven, Liquidity dependent on dealers

3) ETFs: Electronic Trading and Algo Trading are used

4) OTC Derivatives: Dealer market, trade sizes are large. Urgent are principal trades. Non-urgent are agency trades.

5) FX Market: Electronic Trading, Large & Urgent use Request for Quote (RFQ)

37
Q

Trade Execution Measure (Formula)

A

Cost in bps = Side * (Δ% Shares) * 10,000

where
Buy Side = +1
Sell Side: -1
Δ % Shares = (Avg Trade Price - Reference Price)/Reference Price

May be represented in (i) Cost per share or (ii) Cost in bps

38
Q

Market Adjusted Cost (Formula and Concept)

A

Concept: Adjusts the costs to general market movement (which is not YOUR fault)

Formula: MAC = Arrival Cost (bps) - β * Index Cost (bps)

being
a. Arrival Cost = Side * (Δ% Shares) * 10,000

b. Index Cost = Side * [(Index VWAP - Index Arrival)/Index Arrival]*10,000

39
Q

Trade Added Value (Formula)

A

Added Value (bps) = Arrival cost (bps) - Estimated Pre-Trade Cost (bps)

40
Q

Trade Governance (Concept and List)

A

Asset Managers should have trade policies in place to ensure execution and order-handling procedures in line with:

1) Best Execution Duty
2) Optimal execution approach (urgency, rationale, characteristics of trade / securities)
3) List of elegible broekrs and authorized venues
4) Monitoring procedures

41
Q

Best Execution (Concept)

A
  • Identify the appropriate trade-off between
  • Execution Price
  • Trading Costs
  • Speed of Execution
  • Likelihood of Execution
  • Order size
  • Nature of the trade

CFA L3 Matheus (18 decks)

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