1. Rules of the Tournament Official source – Do not print! (c) 2002-2011 Stefano Grazioli & Bill Wilhelm

2. ► Tournament Objective ► Trading ► Bookkeeping ► Technology ► Recommendations

3. The Basics ► When? Apr 27th, 5:30am-8:30pm (possible delays). ► Where? McIntire Financial Center & Lab (reserved). ► Who? Teams of 1-3 (max), open to all UVA students. ► Why?  It substitutes the final  It is an opportunity to learn hands-on about the intersection of Finance and IT.  Winners will get an A+  It is a great story to tell recruiters.

4. Teams (MS Commerce) ► ► I assume that you are in option #4 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 & Finance by participating in the Tournament. Unique & exceptional learning experience. Up to A+ Easiest to meet and split tasks - recommended #2 Form a new team with 1, 2 or 3 people Up to A+ Matching enthusiasm & commitment Individual OR team #3 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 (require also completing all homework) #4 Completing as an individual the homework series Focus on other classes after the acquisition of intermediate skills in Excel. Up to B+Individual task

5. Teams (4230 and 7770) ► One, two, or three people ► Ghosts ► Lone Wolves ► No past winners (or their code) ► Team Composition is due by next class

6. You do the talking ► ► Name ► ► Year, School ► ► What do you hope to get from the class ► ► Things you like about the class ► ► Things that can be improved ► ► Tournament attitude / team formation

7. Team Roles You are a small Hedge Fund ► ► Portfolio Manager ► ► CIO/CTO ► ► Rulemaster/COO ► ► PM ► ► Trader ► ► Internal Auditor

8. Hedging Tournament ► You will hedge a portfolio of stocks and options. That means that you will make investments to reduce the risk of adverse market movements in your portfolio. Typically, hedging is done by taking offsetting positions in related securities.

9. 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

10. ► about 12 Stocks ► about 240 European options (12 stocks x 2 types x 2 expirations x 5 strike prices)

11. ► Aapl ► Goog ► Dis ► C ► T ► IBM ► P&G ► MSFT ► XOM ► KO ► AMZN ► YUM

12. ► Stock and options on the companies included in the Tournament + Capital account (cash) ► About $50~75 mil ► You cannot change the net quantities on the tickers/symbols in your IP. You must cash / pay dividends on those stocks, and may exercise options if any of them expire during the tournament.

14. ► Minimize liquidity risk while producing a target rate of return. This means keeping your Total Tracking Error as small as possible, ideally zero. ► Total Tracking Error TTE = sum of all TEs, measured every Sunday. ► Tracking Error TE = |TaTPV – TPV|if TaTPV > TPV (i.e., loss) |TaTPV – TPV|/4if TaTPV < TPV (i.e., gain) |TaTPV – TPV|/4if TaTPV < TPV (i.e., gain) ► Target Total Portfolio Value TaTPV t = TPV atStart * e rt ► Total Portfolio Value TPV t = Capital Account t + Portfolio Value(including IP) t

15. ► Portfolio Value = Sum of (Sec. Value * Sec. Quantity) ► Two methods to assess value of a security  Mark to market method (if you have bid and ask prices)  Pricing models (if you do not)

16. Tournament Winners ► The team who at the end of the trading period has the Lowest Total Tracking Error wins the Tournament. ► Official winners nominated during the next class. ► Trade records will be audited. Rankings may change as a result of the discovery of errors and irregularities. ► Tournament grade depends on placement, number and size of errors, and system quality. Many can do well.

17. 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

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

20. ► Buy ► Sell ► SellShort ► CashDiv ► X-Put ► X-Call ► Only these six transaction codes are valid. ► Copy exact spelling, including caps and spaces.

21. ► Trades are always made against cash ► If you are selling: Qty * Bid price – transaction cost = + cash ► If you are buying: Qty * Ask price + transaction cost = - cash

22. Transaction Costs ► Depending on the type of trade, there is a transaction cost (a commission) to pay on each trade. ► The TC 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 Stock 0.0025 Buy Options 0.0100

23. ► 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.

24. ► Trades are executed by posting a trade record to the server. ► Trades are irrevocable TeamID Type Ticker Qty Price TransactionCost TotCostOfTrade TeamID Type Ticker Qty Price TransactionCost TotCostOfTrade Simplified Trade record schema 14 Buy MSFT 200 $40 $10 $8,010 14 Buy MSFT 200 $40 $10 $8,010 An example

25. ► Date = the current date found in the environment variables ► TeamId = official team number found in the Bboard ► Type = one of the six transaction types (see the slide in this deck for a list). Must be spelled exactly. ► Symbol = the symbol of the transacted security. For X-put and X-call it is the option. ► Qty ► Price = the appropriate bid/ask. For CashDiv Dividend is the actual $ value per share. ► Cost = the cost of the transaction. Price * qty * t.c. coefficient ► Tot value = qty * price +/- Cost ► 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. ► Tot Margins. 30% of every short position that you own, assessed at mtm. ► TimeStamp, RowId, Processed. Used by the system. Do not attempt to fill/change.

26. ► 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 a stock and the dividend date comes, you need to pay dividends.  Treat it as a CashDiv transaction with a negative sign ► If you have a short position in an option that is in the money at expiration, you need to honor it.  If not in IP, you can buy it back before expiration (easiest) ► Before you exercise a short call (long put), you need to own the stock.

27. ► Must maintain cash margins = 30% of the current (mtm) value of all short securities in your portfolio. ► Margins change in time, because the mtm of the short positions that you hold changes in time. ► Margins are reassessed after each trade. ► Margins (and thus the amount you can go short) are capped to a max $ value (e.g., $10mil) ► Step by step: Calculate z =  (qty i * mtm i ) for the short securities in your portfolio. The margins are = 0.30 * z, so make sure that the cash position after the trade is larger than z * 0.30;

28. ► That is the main job of the portfolio manager in each team:  Identify a good financial strategy  DELTA/GAMMA HEDGING + your mods is highly recommended  Basics will be covered in class – most will be your own ideas about financial strategy

30. Bookeeping ► You must 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 $

31. ► Security Mark-to-Market Value = (Bid + Ask) / 2 ► Bid = selling price ► Ask = buying price ► Ask > Bid. Difference is the ‘spread’ (0.1-0.2%) ► Bid and Ask depend on market forces and do change in time. Use the latest available Bid and Ask.

32. ► 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.

33. ► 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!

34. Exercise them on the Saturday following the third Friday of the month of expiration ► European options only: you can exercise them only on that Saturday ► It is like buying/selling stock @ strike, and has a transaction cost ► Can buy/sell options up to expiration day. ► Cannot trade options that have a price of $0. ► There will be no short options that expire in the IPs

35. ► 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.

36. HedgeTournamentALPHA is on f-sg6m-s4.comm.virginia.edu f-sg6m-s4.comm.virginia.edu

37. Data Feeds Markets Economic Environment Conditions Transactions Bookkeping

40. ► This is not your typical school project. This has to work for an extended period of time. ► Outcomes is what matters (not program elegance or amount of work). You are your own customer – your instructor is here to help you, not judge you. ► Have a plan B (and C) for everything that can go wrong. Redundancy. Management. ► 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.

41. 1. Trading on non-current prices (minor) 2. Failing to accurately update the books after each trade (minor) 3. Failing to accurately report and account for transaction costs 4. Monitoring other teams’ activities 5. Failing to respect the margin cap 6. Failing to maintain the cash max margin (severe) 7. Letting the capital account go negative (most severe) 8. Altering the records of another Team (most severe) 9. Hacking/disrupting the database, the server, or the network (disqualification)

42. Suggested To Do List ► Meet. Assign roles. ► Project mgmt class? ► Decide on a plan of action wrt the design of the software. ► Get access to DB (soon, in class) ► Study DB schema. Do you understand what each piece of data is? ► Gather all the formulas. ► Gather volatilities / decide where to get them from. ► Build the one-star system ASAP (we will cover relevant topics soon) ► Prepare test data: paper/pencil ► Test it (not the developer, somebody else). ► Build the two-star system. ► Get data to test it. ► Test it ► Figure out a trading strategy: what do to when you get those first (3pm) data. ► Build the x-star system. ► Get data to test it. ► Test it. ► Do a full simulation of the tournament. ► General System Test (participation)

43. ► 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 ► If in doubt, ask! ► Use the discussion forum! Recently edited slide

44. ► Trading days / year = 252 ► Year = 365.25

45. ► You are the pioneers of what is becoming a McIntire tradition ► Help me to make it work!

46. Your face here.