Happy 2018 to everyone! And welcome in a world where trading online is the talk of the day, thanks to the rollercoaster-like trends of Bitcoin and the like; at a time when, thanks to MiFID II age beginning just now, the need to strictly follow regulations is stronger than ever in wealth management.
Fortunately we can count on our front office system eXimius: the best choice to manage investment portfolios. In this series of installments we are talking about how to manage derivatives with special attention to hedging and how eXimius works with leverage and margin. Today, you’re guessing it right, it’s time to talk about online trading strategies with eXimius.
Trading Strategies With Options
eXimius offers several option trading strategies to investment managers via multi-leg orders and genuine option trades. The following set of option strategies are in place to purify the margin in an investment portfolio:
- Options of the same Series
- Bull and Bear Spreads
- Time Spreads and Diagonal Spreads
- Covered Calls
- Short Straddle
- Short Strangle
- Butterfly and Condor
- Short Call Options and Long Futures
- Short Put Options and Short Futures
- Synthetic Long Puts
Let’s take a quick look to Options of the same Series and Covered Calls.
Options of the same series
Using options of the same series for purifications is a standard risk hedging strategy based on the combination of long and short derivatives positions in the same series. Options of the same series are typically of the same type, put or call, strike price, currency, number of underlying instruments, expiration date and style, American or European. This strategy therefore limits both the upside and downside risk of the long and short options by combining almost identical options in long and short positions.
Investment manager can also use a strategy known as the covered call. Written call options can for example be purified with long positions in the underlying instrument since the position in the underlying instrument means that the delivery obligations will always be met.
Investment managers can implement, monitor and continually adjust many different trading strategies, based on derivatives, for their clients. The following section briefly describes a few examples of trading strategies, centred around CFDs, that an investment manager can implement in their investments’ portfolios on eXimius.
Leveraged long-only stock portfolios with CFDs
If an investment manager traditionally picks single stocks for their clients, they can choose to add leverage to the investment portfolios by using single stock CFDs instead of single stocks. The obvious upside is that profits will be greater, while on the flipside, losses, when markets go against the positions, will be magnified as well. Leveraging investment portfolios brings the stock-picking investment manager closer to a trading strategy. In case the investment manager decides to leverage heavily, eXimius allows the investment manager to work seamlessly with stop orders on the CFD positions; they could even trail the stops in bulk in all the investment portfolios to ensure losses remain contained. Stop orders are the essential tool for implementing proper money management in leveraged, directional portfolios.
Market neutral strategies with CFDs
If an investment manager has a clear view that a single stock or sector will outperform the general market, but at the same time is not certain of the overall market direction, they could implement a portfolio with long positions in a handful of single stock CFDs or CFDs on sectorial ETFs, while also establishing a short position of the same notional value in the relevant stock index through a CFD contract. The profitability of this strategy will not be determined by the overall market direction, up or down, but rather whether the stocks or sectors the investment manager has invested into outperform the general market.
Another type of market-neutral strategy is pairs-trades. An investment manager might monitor highly correlated stocks within a certain sector to spot unusual divergences or convergences; and upon closer examination might conclude that the convergence or divergence in a pair of stocks is likely to only be temporary, and the long-term correlation is likely to cause the recent trend to revert.
Reduced costs for currency conversion
All of the aforementioned strategies benefit from the fact that CFDs are derivatives, and not cash products. An investment manager might be running client accounts in euro, and therefore generally prefer to limit the investments and trading activity in stocks denominated in other currencies to limit the cost associated with FX conversions. However, if the single stock positions were established with CFDs instead of cash stocks, there would be no currency conversion applicable at the opening or closing of the positions. Currency conversion would only apply to any profit or loss that is generated in a currency different to the account currency, and not the nominal value of the position. CFDs thus greatly enhance the investment manager’s ability to diversify the investments across multiple, international markets.
Added financing costs
CFDs come with an additional financing cost which is not applied when investing via cash-stocks; so while using CFDs for the abovementioned strategies reduces currency conversion costs, the investment manager should ensure that financing costs associated with the CFDs are contained at reasonable levels.
Financing cost are made transparent as of January 2018 due to MiFID II. Some providers deliver the cost via a direct posting on the account monthly. Other providers keep the finance cost in the price but deliver a daily amount as indirect cost to the position. Either way the finance cost shows up in the Total Cost of Ownership.
More to Come for Investors
We’ll have a look in a fourth, and last article to eXimius’ way to provide information to investors while keeping track of their portfolios. Again, happy new year and happy wealth management. Especially with eXimius.