Algorithms Used By Financial Institutions

Enhanced DMA strategies

  • Iceberging: Large order is partially hidden. Max shares shown used as input.
  • Pegging: Order is sent with dynamic price that changes according to market conditions.
  • Smart order routing: Liquidity is aggregated from several sources. Orders are matched to the best price and liquidity.
  • Simple time slicing: Order is split and market orders are sent at regular time intervals.
  • MOC: Order is sent into the closing auction.
Quantitative algorithms
  • VWAP: Uses standard VWAP as a benchmark and attempts to distribute large volume at the best price adjusting for volume traded in the period.
  • TWAP: Similar to VWAP but uses time instead of volume.
  • Participate [Inline, Follow, With Volume, POV]: Trades volume using a fraction as input.
  • MOC: Enhanced MOC with optimized risk and impact.
  • Implementation Shortfall (Execution Shortfall, Arrival Price): Manages the trade off between impact and risk to execute trades as close as possible to a target midpoint .
– A buy-side handbook Algorithmic Trading

BIDU Earnings Play (Ranges)

Closing price (4/27/11) = 151.11
ATM Straddle =  10.8
Expected move = +/- 10.05

Composite of the two:

AMZN Earnings Play (Ranges)

AMZN closing price (4/26/11) = 182.30
Expected move = 10.4
ATM Strangle = 8.6

NFLX Earnings Play (Ranges)

Expected move priced into the market of 21. Position is ITM for a move of +/- 47 with explosive upside on the boundaries.

AAPL Earnings Play

AAPL [Chart]
MMM @ +/- 14.15
Currently trading @ 330
MMM Range: 316 – 344
Entered 2 positions:

  1. Weekly Butterfly – ITM between 315.43 and 324.56 (max return – 1000% @ 320)
  2. Short PUT Vert – ITM above 332.85 (max return – 43%)
Update: Added 2nd weekly butterfly to cover the range 325.83 – 334.20 for extra insurance after the overnight gap up (area between double-dashed red lines is uncovered).

Disassembling an Options Position (AXP)

This is an example of a trade that will take 1-2 months to mature. I began building a position in AXP (with downside bias) on 3/31/11 and it started reversing sharply upward on 4/5 [chart]. By developing a strategy and updating it as circumstances changed, the basis of the underlying MAY short position was lowered and risk was hedged away with an emphasis on efficient use of capital. The overall position in American Express Co. is now positive even though it moved in the opposite direction from what was originally anticipated.

Adjustment Phase (4/5-4/11): [Hedge, leverage, and pull out profit by reconfiguring spreads]
The goal of the entry process was to build a position by layering high probability spreads on top of each other which created an inventory of  goods for sale that could be reconfigured to create something valuable. An emphasis on keeping both risk and capital requirements minimal was prioritized at each level of the trade.

The current inventory of the position can be reconfigured various ways but the simplest way to present it is integrated to stock simultaneously short 300 shares and long 200 shares with a reduced basis in the long MAY PUT. The speculative position is the Long MAY PUT and the rest is the “inventory.” The inventory is hedged against itself elegantly; MAY long synthetic stock vs MAY short synthetic stock and APR short synthetic stock vs the APR 48 CALL. The APR 48 CALL was bought for 0.06 and reduced capital requirements by $600. Deltas are beta weighted to SPY.

The position as of 4/12/11 is composed of the following derivatives:







The trade history for the position is located in the adjustment phase link above and includes detail on how the spreads were taken apart and recombined.

Entry/Setting Up Phase (3/31-4/5):
(3/31) [Start position that takes advantage of time and downward movement]
Enter a diagonal with an embedded long PUT vertical to take advantage of a move down. After Friday expiration the short PUT expires worthless and the basis of the long MAY 11 PUT is reduced by 0.54 to 1.58 (25% reduction in basis of PUT) which moves the break even point up, lowers the risk of the position, and frees up capital.

(4/1): [Reduce basis in PUT and reduce riskPosition (as of 4/1/11)
Sell an out-of-the-money weekly PUT vertical. Since there is an embedded long PUT vertical in the diagonal then I could sell a PUT vertical against it to collect .07 which lowered the basis of the MAY PUT and the risk of the position while freeing up more capital.

(4/4): [Start building a position with high probability spreads]
Sell an April CALL Vertical and a May Iron Condor. Up to this point AXP had been moving with me so I felt confident adding a similar position for April and May expiration.

(4/5) Buy back weekly vertical on short-term play [Next time look for more premium to cover commissions]

P/L on AXP position (4/12)

10 Laws of Daytrading – eBook

10 Laws of Daytrading

  1. Go “Top Down” for best results (wind in your back)
  2. Use market internals to gauge the markets real strength and direction
  3. Know your sectors
  4. Relative Strength is the key
  5. The Pattern is the Last Thing
  6. Stay away from the “Cheapies”
  7. Always Include Volume in Every Analysis
  8. “How Much Can I Lose?”
  9. Use Hard Physical Stops (the shorter the holding period the harder the stop)
  10. Keep a Journal of Trades

– by Peter Reznicek of

Finding and Trading Calendar Spreads

  1. Find front month ATM option with positive skew >= 2%. Implied volatility should be sold should be greater than vol bought.
  2. There should be no earnings close to expiration causing a positive skew.
  3. Volatility in current period should be in the lower 1/3 range over last 6 month period.
  4. Look for an underlying following a channel technical formation.
  5. P/L targets: 20% gain and 25% loss (calculated on margin).
  6. Adjustment occurs at the B/E points. Take off half position and add ATM calendar to widen the spread.