Sunday, October 2, 2011

real time risk monitor ^ real time quote repricer (vol trading)

--Most used app in EQD -- real time risk monitor
A) #1 workhorse -- tick driven position updater with real time greek/unrealizedPNL. Real time unrealized pnl is still important, but EQD trader's #1 concern is the potential gain/loss in MV of her open derivative positions -- real time exposure. Most of the trading decisions are based on this exposure assessment. Real time unrealized pnl doesn't address questions like VAR or "what if".

B) Just like Autoreo, EQD real time risk engine manages entire books of open positions, real time mark-to-market/pnl and risk assessment. However, no automatic adjustment of offer/bid on inventories -- #1 function of Autoreo

C) As another comparison, BofA Quartz is first a risk engine, and 2nd a pricing engine. In many asset classes, the risk engine doubles as a pre-trade pricing engine.

--Most important business factor in EQD -- volatility
In the interest rates business, every player is constantly trying to forecast (and hedge) interest rate fluctuations over various timeframes ranging from 24 hours to 30 years -- the entire yield curve. That forecast drives the entire market and the rates business of every bank. In eq der biz, #1 factor is not IR, not the stock market per se, but volatilities (of stocks and ETF and indices). Volatility as a  concept measures how "wild" is the swing (over a timeframe like 30 days) of any fluctuating price. Over the next 30 days, there's just one such vol, but using bid/ask at different strike prices, you derive different implied-vol values -- welcome to the Smile. A smile is one curve. Using different curves at different expiration timeframes, you get a 3D surface.

Every bank needs to forecast vol using such a surface. Each bank uses a proprietary algorithm, because vol forecast is never straightforward. Yet we must forecast, because vol is the real driver.

Typically, an eq der trader has a lot (hundreds) of open positions to manage throughout the day. (A structured eq der trader has even more long-standing positions.) The main market data of interest is tick data i.e. live bid/ask quotes. Tick drives implied vol surfaces, which drive valuation of non-listed options. Not sure about variance swaps and other eq der instruments, but volatility is the #1 driver.

Q: beside vol, what other business factors are important?
A: open position MV is also sensitive to projected dividends, but they change less often.

In a nutshell, eq der traders need to monitor sensitivity/VAR/pnl-impact in their open positions. These positions change value in response to market data "swings".

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http://www.linkedin.com/in/tanbin