Techniques and Methodologies for

Spread Trading Eurex Equity Index

Futures
April 2009
Name, place, date

Objectives
Presentation Focuses on Structure and Strategy
Create, Trade, and Manage Spreads with the DJ Euro Stoxx 50 and Dax Index
Futures
Identify and Understand the Metrics Unique to Implied Spread Trading
Strategies and Tactics for Trading Implied Spreads

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Objectives

Create, Trade, and Manage Spreads

with the DJ Euro Stoxx 50 and Dax
Index Futures

Benefits to Discretionary Traders

Background of products (DJ Euro Stoxx 50, Dax, ES)
Dual Factor and Multi-Factor Spreads
Walk Through Process of Building a Spread
Contract Ratios
Charting of Spread

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Identify and Understand the Structural Metrics

Unique to Implied Spread Trading
Dealing with Mishedges/Partial Fills/Double Fills
Identifying Work-Arounds for Excessive
Quoting/Messaging
Determining Payup Ticks
Working One Leg or Multiple Legs
Spread Trading Software

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Strategies for Trading Spreads

Alpha Generating Strategies

Trade Factor Analysis

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Background
John Netto
Chief Investment Strategist, NetBlack Capital, CTA
Author, One Shot One Kill Trading (McGraw-Hill, 2004)
President, M3 Capital, LLC (Introducing Brokerage Firm)
Avid Poker Player and Sports Handicapper
Speak Japanese and Chinese
Live in NYC and Las Vegas
Nine Years in US Marines

Name, place, date

Create, Trade, and Manage Spreads

Benefits for a Discretionary Trader
Watch Money Flows in Market
Gain Sense of Relative Strength
Track Volatility
Insight to Risk Aversion/Risk Appetite
Benefit to Currency Traders with Country Specific News
Upward Sloping Yield Curve
Widening Contango or Flattening Forward Curve

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Create, Trade, and Manage Spreads

Presentation will focus on spreading
Dax Index Futures (FDAX)
- 30 German stocks

Dow Jones Euro Stoxx 50 (FESX)

- France (19), Germany (13), Italy (6), Spain (6),
Netherlands (4), Belgium (1), and Finland (1)
- Banks, Utilities, Telco

S & P 500 Futures (ES)

- Widely followed US Equity benchmark

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Components of Dax Index

Ticker

Name

DAX
ADS GY Equity
ALV GY Equity
BAS GY Equity
BAY GY Equity
BMW GY Equity
BEI GY Equity
CBK GY Equity
DAI GY Equity
DBK GY Equity
DB1 GY Equity
LHA GY Equity
DPW GY Equity
DTE GY Equity
EOAN GY Equity
FME GY Equity
FRE3 GY Equity
HNR1 GY Equity
HEN3 GY Equity
SDF GY Equity
LIN GY Equity
MAN GY Equity
MRK GY Equity
MEO GY Equity
MUV2 GY Equity
RWE GY Equity
SZG GY Equity
SAP GY Equity
SIE GY Equity
TKA GY Equity
VOW GY Equity

DAX
Adidas AG
Allianz SE
BASF SE
Bayer AG
Bayerische Motoren Werke AG
Beiersdorf AG
Commerzbank AG
Daimler AG
Deutsche Bank AG
Deutsche Boerse AG
Deutsche Lufthansa AG
Deutsche Post AG
Deutsche Telekom AG
E.ON AG
Fresenius Medical Care AG & Co KGaA
Fresenius SE
Hannover Rueckversicherung AG
Henkel AG & Co KGaA
K+S AG
Linde AG
MAN AG
Merck KGaA
Metro AG
Muenchener Rueckversicherungs AG
RWE AG
Salzgitter AG
SAP AG
Siemens AG
ThyssenKrupp AG
Volkswagen AG
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% Weight in the
Index
1.257489
7.719982
5.843517
6.844599
2.048232
0.599685
0.824506
5.471115
5.493751
2.358737
1.049882
1.934299
6.83274
9.90961
1.308148
0.686946
0.366743
0.832376
1.323569
2.232391
1.018618
1.032586
0.777938
4.702324
5.576428
0.51455
5.787464
9.205364
1.427811
5.018599

Shares in the
Index
11.87955
27.81189
56.38368
46.92168
19.73416
5.00448
40.73869
53.76103
34.50022
11.97068
28.11193
51.58235
182.86181
111.95205
11.4994
4.94616
3.68533
10.93708
7.55626
10.34325
6.38916
4.05831
6.79067
12.03721
25.01387
2.34341
51.4801
50.05453
20.51034
5.29206

Background of Products DJ Euro Stoxx Components

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Background of Products DJ Euro Stoxx Components

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Overlapping Stocks Between Dax and Euro Stoxx 50

ALV GY Equity

Allianz SE

BAS GY Equity

BASF SE

BAY GY Equity

Bayer AG

DAI GY Equity

Daimler AG

DBK GY Equity

Deutsche Bank AG

DB1 GY Equity

Deutsche Boerse AG

DTE GY Equity

Deutsche Telekom AG

EOAN GY Equity

E.ON AG

MUV2 GY Equity

Muenchener Rueckversicherungs AG

RWE GY Equity

RWE AG

SAP GY Equity

SAP AG

SIE GY Equity

Siemens AG

VOW GY Equity

Volkswagen AG

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Components of DJ Euro Stoxx 50 and Dax Index

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Create, Trade, and Manage Spreads

Dual Factor and Multi-Factor Spreads
Dual Factor Spread
Comprised of two legs
Long FESX / Short FDAX

Multi-Factor Spread
Comprised of three or more legs
Long ES, Short FESX and Short FDAX

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Create, Trade, and Manage Spreads

Walk through process of building a spread
Independent Leg/Dependent Leg
Identify Liquid Leg/illiquid Leg
Equalize/Normalize the Spread
Determine Contract Ratios

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Identifying the Independent/Dependent Legs

Independent (Primary) Leg (FESX)
Price of implied spread is based on this leg
When buying spread, going long this leg
When selling spread, going short this leg

Dependent (Secondary) Leg (FDAX)

When buying the spread, going short this leg
When selling the spread, going long this leg

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Identify illiquid/Liquid Legs of Spread

Intermarket spreads - time of day is key
Follow pools of liquidity and volatility around the globe
3 AM Central Time, more liquidity in Eurex
1 PM Central Time, more liquidity in US Exchanges
Intramarket spreads (all Eurex products)

Should use more illiquid leg to work order

E.g. FESX/FDAX FESX more liquid leg / FDAX is illiquid leg

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Equalize or Normalize the Spread

Quantifying the relationship between two products
to create synthetic value
Proper normalization allows for trader to accurately assess the relative
strength between the independent and dependant legs.
Normalization ratios are input into spread trading software to chart
relationship

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Example : FESX/FDAX Spread

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Name, place, date

Example : FSEX/FDAX Spread

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Name, place, date

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Name, place, date

Create, Trade, and Manage Spreads

Chart of Spread FESX-FDAX

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DJ Euro Stoxx 50, Dax, ES, NQ, TFE (Mini Russell)

- Last 30 Calendar (23 Trading) Days -

4-24
Totals

Contract

Range (Point/Ticks)

Range (Currency)

Range (US Dollars)

TFE

202

2020

2020

NQ

42

840

840

ES

27

1350

1350

FDAX

138

3450

4586

FESX

73

733

995

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Create, Trade, and Manage Spreads

Contract Ratios
Lead Leg

ES

FDAX

FESX

NQ

FDAX

2/7

N/A

2/9

1/5

ES

N/A

7/2

7/10

2/3

FESX

10/7

9/2

N/A

5/6

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Structural Metrics Unique to Implied Spread Trading

Dealing with Double Fills/Mishedges/Partial Fills
Double Fills As a result of changing orders b/t exchange
and trading software, risk of multiple fills and either short or
long position in market takes place
How do double fills happen? Working both legs in an attempt
to maintain queue preference
Premium placed on server location, speed of transmissions
Check message turnaround time

Example: Working both legs of Long FESX/FDAX spread

Near simultaneous fills take place of long 9 FESX and short 2 FDAX
Spreading software will send hedge orders of corresponding leg, in essence
selling 2 more FDAX and buying 9 more FESX
The result can be long 18 FESX, short 4 FDAX or somewhere in between

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Mishedges/Hung Legs
Working a spread and having one leg filled
and other leg unfilled
Example: Working long 10 x 7 FESX/ES
spread

Filled on long 10 of FESX, while short 7 of ES is still working

Hang risk larger for more volatile markets or news events
Addresses issue of payup tick logic
Contract ratio logic per hang risk

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Partial Fills
Partial Fills While working a spread, only part of the leg is
filled leaving you vulnerable to systemic risk
If partial takes place in general market trend, usually more
flexible to let it work
If partial takes place against trend, more aggressive to flatten
out

Example Working a long 9 x 2 FESX/FDAX spread and 3

contract buys on FESX leg are filled.

Not enough to hedge out with 1 big Dax, but still market risk
Solutions
-

Name, place, date

Accept the risk and stay long

Close position with 3 lot sell on FESX
Hedge out with ES

Structural Metrics Unique to Implied Spread Trading

Identifying Work-Arounds for Excessive Quoting/Messaging
Excessive messaging can slow system performance/negatively impacts
market participants/increases capacity requirements and costs

A message any Order, Modification, or Cancel for a product

Understanding the Volume Ratio
Dividing total number of messages by total executed volume

Notices and Surcharges

Firm is fined $2,000 per occurrence as technology surcharge and potentially
more if issue occurs consistently

Potential Solutions
XTrader AutoSpreader Smart Quote Limits
CQG Ninja Mode which works orders later
FCM If FCM (Class A firm) is doing lots of volume it can help offset
excessive messaging
Reference:
Eurex Circular February 9, 2009 Adjustment of the Architecture Throttle
http://www.cmegroup.com/globex/files/CMEMessagingPolicy.pdf
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Structural Metrics Unique to Implied Spread

Trading

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Structural Metrics Unique to Implied Spread Trading

- Determining Payup Ticks
Why are Payup Ticks So Important?
Executing strategy is pinned against fills at implied prices
High volume game and slippage can significantly detract from
efficacy of strategy

Spreads Dont Happen in Vacuum

Same dynamics which create opportunities create obstacles

Strategies

Set Threshold for max slippage for each transaction

Set Limit plus
Set Trailing plus
Work market on side of direction you think market is headed
- E.g.. If working Long FESX-FDAX spread and market is rallying,
work long leg (FESX) and use short leg with no payup ticks. i.e.
get hung long in rising market, not hung short

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Structural Metrics Unique to Implied Spread Trading

Factors in Working One Leg or Multiple Legs
Liquidity
Deeper markets make multiple leg quoting potentially more
beneficial as queue preference materially impacts
performance of active trading

Volatility
More volatile the market, greater risk for mishedging

Messaging/Quoting Limits

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Background
Patrick S Hemminger
Head Equity Index / Commodity Trader at NetCap Advisors
8 years Experience Managing Proprietary Portfolios
Experience trading

Equity Indexes
Commodities (Oil, Products, Grains, Meats)
Currencies (Spot, Futures)
Treasuries (Futures, Cash)

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Alpha Generating Spread Strategies

Eurex vs. Eurex and Non-Eurex vs. Eurex Spreads
FESX vs. FDAX
ES vs. FDAX
ES vs. FESX
Trade Factor Analysis
Pre Trade Analysis

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Identifying Areas of Value

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Spread Examples
FESX vs. FDAX

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ES vs. FDAX

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ES vs. FESX

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ES / FESX / DAX Fly

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Trade Factor Analysis

Normalizing, why?
- Cohesion / relationship
- Replication
Normalization Factors
- Instrument Tick Value
- Instrument Notional Value
- Instrument Base Currency
- Instrument Historical Volatility
- 60 Day
- 30 Day

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Trade Factor Analysis

Benchmarking - ES
- Global Equity Index Benchmark, the Standard
- Provides focus
- Manage Expectations / Performance
- Most Liquid
- ES 100MA = 2.5 MM per day
- FESX 100MA = 1.5 MM per day
Currency Component
- Instrument Base Currency
- Residual Balance Strategy Intraday / End of Day
- Hedge w/ Future
- Exchange for Physical (EFP)
- Spot Transaction
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Pre-Trade Analysis - KISS

Beta - Quick and Simple
- Gauging Price Fluctuations
- Where is the Risk / Volatility - Time
- Benchmark
- Relationship between Dependent &
Independent
- Liquidity

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Pre-Trade Analysis
Time of Day Analysis
- Be Aware of Open and Close Times
- Organize Day
- Time Brackets
- 9 Separate Brackets
- Time of Day for Opportunities
- Probabilities

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Pre-Trade Analysis
Long Term Standard Deviation Analysis
- Bollinger Bands
- +/-1 = Momentum
- +/-2.5
- Distance Between Bands
- Slope of Bands
- Historical Effectiveness
- Coast - to - Coast

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Bollinger Band Example

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Market Profile
Long Term Standard Deviation Analysis
- Time Price Opportunities
- Point of Control
- Value Area High (VAH)
- Value Area Low (VAL)

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Market Profile Example

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Technical's

Trend lines
Double Tops / Bottoms
Fibonacci Retracements
Slow Stochastic
Complimentary Markets
Top Down Approach

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Technicals
Trend lines / Double Tops / Double Bottoms

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Technical's
Fibonacci Retracements

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Technical's
Fibonacci Retracements

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Technical's
Slow Stochastic (SStoch)

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Technical's
Complimentary Markets

Be Cognizant of Constituents
Identify Sectors Under / Out Performing
What markets are in the news
Currencies
- EURUSD
- GBPUSD
- EURJPY

Be aware of Constituents in the Commodity Industry

- Oil
- Gold

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Technical's
Top Down Approach
Anchor Charts
- Daily / 30 min / 5 min

Trade on the side of the market

Contrarian positions
- Managing Risk
- Take a loser, Opportunity Cost

Tape Read / Feel

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Contact Information
John Netto
[email protected]
212-315-0650
www.osoktrading.com
www.netblackcapital.com
www.m3capital.com
Capital allocations, consulting, boutique
brokerage services, sell-side / buy-side
conferences, trader education
Name, place, date

Contact Information
Patrick S Hemminger
[email protected]
630.723.4730

Name, place, date

 Eurex 2009
Deutsche Brse AG (DBAG), Clearstream Banking AG (Clearstream), Eurex Frankfurt AG, Eurex Clearing AG (Eurex Clearing) as well as Eurex Bonds GmbH (Eurex Bonds) and Eurex Repo
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