.. slideconf:: :slide_classes: appear ============================================================================== Trading ============================================================================== Exchanges Today ============================================================================== Modern financial exchanges are typically *electronic communications networks* or *ECNs*. .. raw:: - They consist of large warehouses, populated by computer servers that electronically match orders. .. raw:: - These are referred to as *matching engines*. .. raw:: - Since order execution speed is so important, many traders co-locate their trading computers with the matching engines. Exchanges Today ============================================================================== .. ifslides:: .. image:: Trading/servers.jpg :width: 7.5in :align: center .. ifnotslides:: .. image:: Trading/servers.jpg :width: 6in Major U.S. Exchanges ============================================================================== - The `NYSE Arca `_ matching engine is located in Mahwah, NJ. .. raw:: - The `Electronic Broking System (EBS) `_ currency exchange is located in Secausus, NJ. .. raw:: - The `Chicago Board Option Exchange (CBOE) `_ has co-located with EBS in Secaucus. .. raw:: - The `Nasdaq `_ matching engine is located in Carteret, NJ. .. raw:: - The `CME Group `_ matching engine is located in Aurora, IL. Exchanges Today ============================================================================== .. image:: Trading/exchangeMap.png :width: 7.5in :align: center Exchanges Today ============================================================================== .. image:: Trading/microwave.png :width: 8.5in :align: center Exchanges Today ============================================================================== .. image:: Trading/worldExchanges.png :width: 8in :align: center Market Makers ============================================================================== Participants on exchanges include makers and takers. .. raw:: - Makers are required to post both quotes to buy and sell assets on the exchange. .. raw:: - Quotes to buy are called *bids*. .. raw:: - Quotes to sell are called *offers*. .. raw:: - Typically there are many bids and offers posted on the exchange at different prices. .. raw:: - Market makers are compensated for providing quotes (also referred to as *providing liquidity*). Takers ============================================================================== Takers actively *take* orders that have been passively posted by market makers. .. raw:: - When a taker wants to buy the asset, they buy at the lowest posted offer quote. .. raw:: - When a taker wants to sell an asset, they sell at the highest posted bid quote. .. raw:: - The difference between the highest bid quote and lowest offer quote is known as the *spread*. Order Book Example: time 1 ============================================================================== .. image:: Trading/orderBook1.png :width: 7.5in :align: center Order Book Example: time 2 ============================================================================== .. image:: Trading/orderBook2.png :width: 7.5in :align: center Order Book Example: time 3 ============================================================================== .. image:: Trading/orderBook3.png :width: 7.5in :align: center Order Book Example: time 4 ============================================================================== .. image:: Trading/orderBook4.png :width: 7.5in :align: center Order Book Example: time 5 ============================================================================== .. image:: Trading/orderBook5.png :width: 7.5in :align: center Information Flows ============================================================================== Conventional wisdom is that information flows from the futures market to the equities (cash) market. .. image:: Trading/cmeQuote.png :width: 7.5in :align: center SPY Liquidity Response to ES ============================================================================== The following figure shows average net SPY liquidity response (shares added to offer minus shares added to bid) in each millisecond following ES liquidity change. .. image:: Trading/liqResponse.png :width: 5.5in :align: center Reasons for Information Flow ============================================================================== - The standard explanation is leverage. .. raw:: - Informed traders will first trade where they can obtain highest leverage. .. raw:: - The data also suggests that *relative price increment* is an important determinant. SPY/E-mini Contract Specs ============================================================================== E-mini: .. raw:: - Quoted in S\&P 500 index points. .. raw:: - Notional value of one contract is 50x the index. .. raw:: - Minimum price increment is 0.25 index points. .. raw:: SPY: .. raw:: - Quoted at 1/10th the value of the S\&P 500 index. .. raw:: - Notional value is equal to the price quotes. .. raw:: - Minimum price increment is \$0.01. - Equivalent to 0.10 index points. .. raw:: E-mini tick size is 2.5x SPY tick size. E-mini/SPY Spreads ============================================================================== .. image:: Trading/spreads1.png :width: 7.5in :align: center E-mini/SPY Spreads ============================================================================== .. image:: Trading/spreads2.png :width: 7.5in :align: center E-mini/SPY Spreads ============================================================================== .. image:: Trading/spreads3.png :width: 7.5in :align: center E-mini/SPY Spreads ============================================================================== .. image:: Trading/spreads4.png :width: 7.5in :align: center Spread and Information Flow ============================================================================== Differences in spreads creates arbitrage opportunities. .. raw:: - The size of the spread differences determines size and frequency of arbitrages. .. raw:: - Large ES spread relative to SPY spread means big arbs most of the time when a market maker is filled at CME. .. raw:: - Less frequently, the SPY bid or offer will allow an arb in the reverse direction. Implications ============================================================================== - If maker is filled at ES bid and ES bid \< SPY bid: sell at SPY bid. - SPY market responds to ES market. .. raw:: - If maker is filled at ES offer and ES offer \> SPY offer: buy at SPY offer. - SPY market responds to ES market. .. raw:: - If maker is filled at SPY bid and SPY bid \< ES bid: sell at ES bid. - ES market responds to SPY market. .. raw:: - If maker is filled at SPY offer and SPY offer \> ES offer: buy at ES offer. - ES market responds to SPY market. Empirical Results ============================================================================== .. image:: Trading/bidResponses.png :width: 7.5in :align: center Empirical Results ============================================================================== .. image:: Trading/offerResponses.png :width: 7.5in :align: center Notes on Results ============================================================================== - The previous results are base on the trading record from Aug 2015. .. raw:: - The data strongly support the model predictions. .. raw:: - There are typically 10 times as many ES events as SPY events. .. raw:: - Each SPY event is 10 times more influential than an ES event. .. raw:: - What does this mean if you are designing and exchange?