Trading

Question 1

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VWAP vs IS

Answer 1

VWAP

Low urgency

Narrow Bid-Ask

Low order size

IS

High urgency

Narrow Bid-Ask

Low order size

Question 2

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Explicit costs

Answer 2

commissions, taxes, stamp duties, and fees.

Question 3

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Implicit costs

Answer 3

bid-ask spread, market or price impact costs, opportunity costs, and delay costs (a.k.a. slippage costs).

Question 4

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VWAP Implicit cost

Answer 4

Implicit cost = # shares * (Executed price – VWAP)

• Best with low volumes
• Narrow bid-spread and
• LOW urgency to complete the trade

1. Distorted in large trades, misses delay cost, can be gamed (VWAP is defined intra-day, trade may be postponed)

Question 5

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Algorithmic Trading

Answer 5

Algorithmic Trading - execute orders with minimal risk and costs.

1. Logical participation
   
   1. Simple logical participation (SLP): trade in proportion to trading volume to minimize market impact.
      
      1. VWAP – break-up order to match or improve expected VWAP
      2. TWAP – trade a constant fraction of flat volume (to blend out during day) - takes longer to execute
      3. % of volume – trades as a proportion of the volume
   2. Implementation shortfall strategies: minimize trading costs using IS - used when urgency is a problem!
2. Opportunistic – passive trading that takes advantage of liquidity when present - urgency is not an issue
3. Specialized Strategies – Hunter strategy

Question 6

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Implementation Shortfall (IS)

Answer 6

CD-ROM

Straightforward approach:

1. Possible return ($) = Shares_wanted * (Price_closing - B_enchmarkP_rice)
2. Total effective cost ($) = Shares_bought * (Price_{paid +} Cost_pershare)
3. Effective Return ($) = Shares_bought * Priceclosing

• ​(=) Return Missed ($) = Possible Return - Effective Return
• Implementation Shortfall (%) = Return Missed / (Shares_wanted * BP)

Question 7

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Effective spread

Answer 7

Effective spread = 2 × (Actual execution price − Mid-point of market quote at time of order entry)

Quoted spread = ask - bid

Mid-point = (ask + bid) / 2