hedge/ spread ratios

CALLumbus · May 25, 2014

Hi,

could you guys help me with hedge/ spread ratios for all possible pairs with the following instruments:
FDAX, FESX, ES, YM, NQ

I guess especially bone might help me with this :-)

Also some input how to get these ratios (calculations, software, website) would be very nice.

Greetings,
CALLumbus

nazzdack · May 25, 2014

CALLumbus said:
----hedge/ spread ratios....
----all possible pairs....
----FDAX, FESX, ES, YM, NQ
----input how to get these ratios....

1) In a nutshell, the average daily dollar-volatility fluctuation of one compared to the other.

2) When you start trading those spreads, the ratio fluctuates in your favor.

2rosy · May 25, 2014

heres some spread ratios, pca loadings, etc. The formulas used you can get off wikipedia or google them

bone · May 27, 2014

nazzdack said:
1) In a nutshell, the average daily dollar-volatility fluctuation of one compared to the other.

Basically true - we use a 20 day rolling or on-the-run comparison. It's as good a technique as any other out there ( and there are many).

The only other point I would add is that you absolutely want to make sure that the products you are spreading have a very high positive correlation to each other ( my personal preference is > 93% ).

You will also want to make sure that the exchanges offer a SPAN margin credit for your particular spread combination of interest if you are modestly capitalized. Otherwise, your clearing firm is likely to treat each product as outright flat price risk.

Good luck with things.

londonkid · May 27, 2014

bone said:
The only other point I would add is that you absolutely want to make sure that the products you are spreading have a very high positive correlation to each other ( my personal preference is > 93% )

That is an interesting point you make on correlation. I have had much more success using co-integration to select candidate spreads rather than correlation. Generally speaking I found that a high level of co-integration usually means a high level of correlation however the other way around it is not necessarily so.

bone · May 27, 2014

londonkid said:
That is an interesting point you make on correlation. I have had much more success using co-integration to select candidate spreads rather than correlation. Generally speaking I found that a high level of co-integration usually means a high level of correlation however the other way around it is not necessarily so.

While I don't necessarily disagree, the basic simplicity of his question compelled me to offer up "quick and dirty" in lieu of a financial engineering exercise. As I mentioned in my original post, there are various techniques to calculate deltas between products.

In fact, probably the best thing for the OP to do would be to use the CME and ICE and Eurex published inter-commodity SPAN credit ratios now that I think about it.

londonkid · May 27, 2014

bone said:
As I mentioned in my original post, there are various techniques to calculate deltas between products.

Surely you mean various techniques to calculate betas not deltas between products as we are talking futures here. We are aiming to be beta neutral not delta neutral. please correct me if I am wrong.

bone · May 27, 2014

londonkid said:
Surely you mean various techniques to calculate betas not deltas between products as we are talking futures here. We are aiming to be beta neutral not delta neutral. please correct me if I am wrong.

Yes, you are absolutely correct using the term Beta. But exchanges and data providers do not always use the academically correct terminology.

Please be advised that CME uses the term " ratio credits" and ICE uses the term "deltas" in their inter commodity SPAN margin procedure. No mention of Beta.

From ICE:

"The amount of spread credit is determined by the relationship between the two commodities and is set by the ICE Clear U.S. Risk Department. Spreads are sorted by the percentage savings. The highest percentage saving spread is given the highest priority. Spreads are formed using the net deltas of the commodities in the order of spread priority.
SPAN isolates the futures price risk per delta for each commodity and the margin is reduced by this amount multiplied by the percent saving for any spread that is formed. Information on Inter- Commodity Spread Credits is distributed each day with the parameters that accompany the risk arrays."

Again, I think the simplest approach for the OP would be to use the inter commodity ratios published daily on the exchange websites.

As you rightly point out - it's not technically correct per se, but it is what it is.

londonkid · May 27, 2014

bone said:
Yes, you are absolutely correct using the term Beta. But exchanges and data providers do not always use the academically correct terminology.

Please be advised that CME uses the term " ratio credits" and ICE uses the term "deltas" in their inter commodity SPAN margin procedure. No mention of Beta.

From ICE:

"The amount of spread credit is determined by the relationship between the two commodities and is set by the ICE Clear U.S. Risk Department. Spreads are sorted by the percentage savings. The highest percentage saving spread is given the highest priority. Spreads are formed using the net deltas of the commodities in the order of spread priority.
SPAN isolates the futures price risk per delta for each commodity and the margin is reduced by this amount multiplied by the percent saving for any spread that is formed. Information on Inter- Commodity Spread Credits is distributed each day with the parameters that accompany the risk arrays."

Again, I think the simplest approach for the OP would be to use the inter commodity ratios published daily on the exchange websites.

As you rightly point out - it's not technically correct per se, but it is what it is.

I think you misunderstood my post. I wasn't saying that the CME or ICE used the term 'Beta' in their SPAN margin procedures. I said:

londonkid said:
Surely you mean various techniques to calculate betas not deltas between products as we are talking futures here. We are aiming to be beta neutral not delta neutral. please correct me if I am wrong.

The CME and ICE use the terms 'ratio credits' or 'deltas' in different (their own) contexts. In short they don't use delta to mean beta they use delta to mean delta. When wanting to quote the spread ratio they call it the 'spread ratio'.

see here page 19: http://www.cmegroup.com/clearing/files/span-methodology.pdf