hello dax

FUTURES, THE MARKET AND ITS PARTICIPANTS (III): A COMPARISON

Future markets are generally considered as zero-sum games. A zero-sum game is a game in which the net return of all players, eg. investors or traders in total equals just zero. This means that when somebody loses, somebody else makes a profit so that in average in the long run losses equals profits. This does not mean that nobody can win on average, what it means is that at future markets a (huge) redistribution of money takes place. Who wins in this game?

It is considered, though, that some groups of players on average lose and some groups of players structurally win. Numerous researches confirm this see eg. L. Harris, Winners and Losers of the Zero-Sum Game . This result is not only restricted to future but also to stockmarkets and valutamarkets (FOREX).

The Commodity Futures Trading Commission (CFTC) , which publishes weekly reports containing details of holdings for market-segments containing data on open interest for commercial and non-commercial market participants (Commitments-Of-Traders'-Report, COT-Report or simply COTR).

The CFTC segregates the various groups operating at the markets into several categories.

• One contains so-called large "commercial" traders, the hedgers.


• The second contains so called large "non-commercial" traders - large speculators, in other words.


• A final category contains all those that don't fit into the other two categories, presumably small speculators, the public traders.

For EUREX products (FDAX, EUROSTOXX50, GBL) these data are not available but only product or product group are collected. How do these groups perform in comparison?

The CXO Advisary group, a small market research and publishing company that summarizes research that is relevant to investing, gathered some historical performances of these groups on the S&P 500. Some of their findings are:

• that the non-reportable small speculators (the "public") tend to take the opposite side of the positions of the commercial traders



• and more importantly the commercial traders leaning right and the public leaning wrong, when having futures positions.



• Also, it appears that small players suffer bear markets more than they enjoy bull markets.

These findings are found over and over again: small traders (public) lose money to big professional traders on average. This doesn't withold these kind of traders from the markets: in contrary. Small traders are in fact operating more and more on the markets despite their probable failure as a group, a phenomene that has been investigated by Dorfmeister for the EUREX Future markets.

He considered the fact that various groups on the market have different motives and time horizons when trading and he used daily open interest and volume data to calculate average holding period of the various future products traded on the EUREX which are the FDAX, EUROSTOXX50, Euro-Bond (FGBL), Euro-Bobl (FGBM), Euro-Schatz((FGBS) and EURIBOR. Data sampling is done since the opening of the respective future contracts eg. for the FDAX since 1999. He found and concluded that:

• The Eurex gives home to some futures (namely the FDAX, the FGBL, the FGBM, and
  the FGBS) which reveal very short-termed trading behavior of market participants.



• Within their investigation period they could observe a tendency to even more short-term
  behavior in all futures.



• This means that possibly there are huge masses of day traders in these futures.

Off course there are more parties involved with trading: brokers, datavendors, market makers, arbitrageurs, regulators, market organisers and so on, all with different motives and goals, 'many mouths eating from the market'. Paolo Pezzutti recommends Market Microstructure for Practitioners , a book about products, market participants, regulations and market organisations

I was thinking the last couple of days about the market and the doom scenario's some described, comparing this market with the fall of the late nineties after 1997, talking about inflation risks and FED's chairman Greenspan commenting about the market and inflation.
Off course the usual conspiracy theories always pop up.

Niederhoffer posting about the common errors made by forecasters, quite amusing to read.

Markets started two weeks ago to go down rapidly, an end of a trend , off course I meant the trend of this year which started in November of last year; though the DAX still is in a big uptrend since 2003, see a classical uptrend in the chart below (click to enlarge).

Markets bounced up thursday, there were some clues though given by some. So Stephan Vita who posts this graph of the NYMO McClelan indicator, an indicator more often used by index followers, and asking the retorical question : "Why Does a Bounce Come?" ; it speaks for itself.
The S&P 500 bouncing off the 200 SMA very neatly: safed by the bell a least for the moment.

I am allways very cautious about predictions because who can predict the future? But to be honest I saw wednesday the FDAX nice bottoming out, with a double bottom and a positive divergence in price at C assuring at least a short term recovery.

Also read again Niederhoffer when he is Briefly Speaking about the markets and about romance too :)

FDAX
Dow Jones

Hi everyone,

When at the end of the day we look at the fdax charts, we can't help thinking that we could had made a lot of money if only we knew when to buy and when to sell.
Off course that what we just said is the same thing millions thought way before us. Some of them gave up, some of them insisted in luck (we bet that almost all lost) but some stopped for a while and tried to figure out a way to earn real money with fdax.

We want to belong to the last group, the group that learns, sometimes with mistakes, but without giving up or waiting for luck to come. Given what we just said an idea came to us, what if we came up with a plan that instead of "guessing" what fdax will do next, earned money with both variations up and down. This was the genesis of what we call Slice & Dice.

The plan is simple, we know for a fact that in the long run fdax grows, so every investment in buys that has sufficient risk margin to survive falls, even big ones, is safe. On the other hand we can never be sure that put positions, even large ones, are safe from a big climb of the index.

The way we think that is possible to earn both ways is to have x number of calls with low risk and y number of puts with high risk, given x > y.
This way we would buy them at the same time and drop the puts at a pre-established threshold and then wait for the index to climb and drop the calls to at that threshold.

One thing Slice & Dice gives to is the guarantee that even if we are stopped on the puts, dropping the calls still makes the operation profitable.

Here´s an example of what we said.

fdax is at 6100
we buy 4 calls with 200.00$ risk (306 ticks / 153 fdax points) (cost of operation with commissions 818.00$; Stop point 5947)
we buy 2 puts with 22.87$ risk ( 36 ticks / 18 fdax points) (cost of operation with commissions 53.48$; Stop point 6018)
Total cost of operation 871.48$

First Scenario:
fdax goes down below 6085: We sell the puts at 30 ticks getting 29.12$ profit.
We wait until fdax gets up and sell the calls at 6015 getting $58.25 profit.
Total of operation 87.37$ profit

Second Scenario:
fdax goes up above 6018:
We get stopped on the puts and loose 53.48$
We sell the calls at 6015 getting 73.50$
Total of operation 20.02$ profit

Up:With "normal" fdax behaviour we never loose.

Down:Calls must be very strong (maybe 200$ isn't enough)
We can get stuck without trading for a while until the system hits 6015 again.



Note: All simulations are made in enetspeculation system and with enetspeculation commissions already included in profits.

While hedging has been the initiator of the existence of future markets, speculation became an important role for price driving on the markets . As soon as parties started to trade future contracts before it's settlement and delivery this new aspect came into being. Speculators were not anymore interested in the delivery of the underlying product but only speculate about it's value. So future contracts becoming a market like any other market of tradeable goods determined by ask and demand.

This arises the question how prices of futures and their underlyings mutually influence each other. I won't go deeper into this question, which is merely a question about market and price theories but it is generally seen that future prices tend to be higher than the underlying product, a difference known as "premium".

Factors influencing the premium of a future are the interest rate, the dividend yield when stocks are concernend and future expectations of the underlying which depends on the duration time of the future. The most comprehensive model on prices of futures being the Black and Scholes model based on perfect market theories.

These factors generally have positive values, with exception of the dividend yield which has a negative contribution, resulting in the premium a buyer (the long side) of a future contract has to pay. More about future prices.

In general the premium being the biggest at the opening of the future contract, tending to go to zero during it's lifetime and being exactly zero at settlement (at expiry date). This overall decreasing value of premium being one of the reasons a man like Soros preferes stocks and commodities over derivatives as futures because there is no such thing as premium involved with these.

Next time more on the various parties on the market and a comparison how they act.

We ( me and fernando ) are trying to make a technique and apply it to DAX. The idea is simple. We mantain long positions of calculated risk, let's say 5 x 200€ positions. In the meanwhile he open 3 x 30 € short positions. This way we "never" lose. If we got stopped on the short positions, we profit on the long ones. If we get to a profit treshold on the short positions, we buy, and profit from the short positions. The long ones are "big" enought to hold the short ones and not beeing stopped, and we wait the index to go up again, profit with the longs and repeat the whole process.

Does it work ? We don't know. Not tested yet :P

To trade future markets succesfully one must be aware of various things but the first thing to know is the role of futuremarkets and it's main participants.

Live is full of risk and especially to those producing or merchandising products with varying prices. When after the Middle Ages market economy came into development people tried to avoid and to handle these risks and one of the ways they managed this was by creating option and future markets. Not surprisingly the first time in the economic centre of the world in those days Amsterdam.

Futures are contracts between a buyer (he is been said to go long>) and a seller (he is said to go short), a contract in which they agree on a price for a delivery in the nearest future for some kind of product, a product known as underlying.
Suppose a farmer producing some kind of crop. He doesn't know the outcome, and the price of his crop nor from his competitors. A potential buyer doesn't know either.

A future contract between these two parties, the farmer and the potential buyer, to deliver the crop in harvest for a certain price guarantees both a fixed price to diminish their risks. It is important to stress that the fixed price is in itself a risk because the real price of the crop may and will be differ from the fixed price in the contract. They both assume their expections on future prices of the crop on hisitorical and current prices of the crop, amongst various other things as the weather conditions, technology, expectations on future demand and so on and on.

An example may clarify this. A farmer produces somekind of corn. He expects his costs to be 100 euro per ton. Last years price was 105 euro per ton. The farmer knowing his efforts and the problems he has with this years crop expecting his price at the market only to be at 95 euro. The farmer having inside information about his product. The potential buyer at the other hand has a more broader view of the overal market, the competitors, the demand and the total supply. This is his job. He has a market overview and is expecting this years harvest price to be 115 euro.

So both parties, the producer and the buyer of the crop, have different expectations about the price of the same product, both based on different assumptions and information. They both know this and hence there is a risk to be wrong. So they decide to agree at a fixed price of the delivery of the crop at harvest at say in between their expectations at 110 euro per ton. Three things can happen.

1. The price at harvest is exactly 110 euro. The delivery of the crop to the buyer at 110 euro, the future contract will be ended with this delivery, a proces which is known as final settlement. The farmer wil get 110 euro, a price which he also would have get without the future contract, making 10 euro (110 minus 100 the cost) per ton. The buyer getting delivered for 110 euro making no loss nor gain, but also a price he would have get elsewhere. This being rarely the case.

2. The price will be 120 euro. The settlement is arranged at 110 euro, but now the buyer of the crop is getting a profit of 10 euro (120 minus 110) because he can sell the crop at market for 120 euro, which is the current market price. The farmer at the other hand has a profit of again 10 euro, his delivery price 110 minus his costs at 100, but now he also experiences what is called an opportunity loss of 10 euro because he could have sold his crop directly to the market at 120 euro, but he is obliged to deliver at the buyer at 110. This opportunity loss is the risk the farmer takes by making a future contract for his crop.

3. The market price will be lower than fixed settlement price at say 95 euro. Now the buyer loses money. He has to buy at 110 euro but only can sell at 95 at market making a loss of 15 euro. The farmer still making a profit of 15 euro (110 minus 95) but after costs making a win of 10 euro. The future assuring him of getting a price above markets (and in his case even above his costprice).

This proces to assure the producer of a fixed price of his product is called the hedging function of the future market and is still nowadays the most important function of this market. Futures nowadays are traded on almost any product ranging from commodities as oil, gold, soybeans, cattle, the moneymarkets as euro/dollar or euro/yen to stock indices as the S&@P 500 future.

Traded originally at the floor at market places, called pit trading, but the last 10 years with the use of computers they are more and more executed at virtual places called electronical markets like GLOBEX organised by the Chicago Mercantile Exchange or the EUREX organised by Deutsche Boerse AG in Frankfurt.

Some futures still being traded solely at the pit as some commidities are, others traded both at the pit and electronically such as the big S&P 500 future, others as the German future at the DAX index (FDAX) or the mini S&P500 are traded only electronically.

It is important to note that the oponent of the hedger is bearing all the risk of the contract so why is he doing this anyway? This will be the subject of the next posting which will be about the other important function of the futuremarkets: speculation.

long 6053.5
close 6062
net 8.5 ticks

short 6074
close 6070
net -4 ticks

FDAX @ 6031

This blog features the journey of two guys between the big world of future trading. We will be sharing our daily trades on the german index DAX. We have chosen DAX because it's a very popular index, high volatile, good for intraday trading. Since we are trading futures, we will be trading on the Eurex. More on that later...

"DAX (abbreviated from Deutscher Aktienindex) is a Blue Chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. Prices are taken from the electronic Xetra trading system. The L-DAX Index, is an indicator of the German benchmark DAX Index's performance after the Xetra electronic-trading system closes. The L-DAX Index basis is the "floor" trade (Parketthandel) at the Frankfurt stock exchange; it is computed daily between 17:45 and 20:00 Hours CET. The Eurex, a European electronic futures exchange based in Frankfurt, Germany, offers options (ODAX) and Futures (FDAX) on the DAX."
This info was taken from wikipedia.

We will try to share the information on a daily basis, but as we both have full time jobs, sometimes will be difficult to update the blog.