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C. Statistics |
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Futures
Closeouts
This page has
considerations for design around ‘Closeouts’ for Exchange Traded (‘listed’) Futures
and Options context of CTRM system design.
Here is how
closeouts work…
First.. they are only for
Exchange-traded items. We’ll use Futures
as the example for this e-mail, though they would also apply for exchange
traded options on futures.
As an example, NYMEX CL (WTI Crude) futures.
From now on, we’ll
call them ‘Futures Closeouts’ though I really mean Futures/Options/etc. Just to make it simpler for communications…
There are two
key aspects to Futures Closeouts
1) Volume of
trades (trade count), i.e., as relates to performance
2) Recognizing
PnL, i.e. ,Realized PnL. This is from an accounting (subledger/ledger) point of view.
Here is how it
works on the exchange, using some examples.
Example 1)
You buy 10
futures, e.g., Dec-2022 CL, at $87/BBL.
Let’s assume
that this is booked as a single trade in a CTRM system and gets deal number
100001
Then next day
you sell 4 futures, same contract code (CL) and same month (Dec-2022) at $88/BBL. Let’s assume this is also filled as one Deal,
booked in the CTRM system as Deal# 100002.
So what is
going to happen on the exchange side.. .they are doing to show you as long 6. They net things on their end. The money you made would be in your account,
yours to do with what you please. The
money you make is $1 (= $88 - $87) times the Contract Size (1000 BBL in this
case, see above link for the contract specs) times the number of contract
(=4). i.e.., $4000 in
profit.
In summary,
when you look at what the exchange shows for you, you’ll see:
$4000 profit
And long 6
Dec-22 CL contracts at a price of $87.
So what does
it look like in a CTRM System?
Without a
closeout process, you would have
a) Still 2
active trades…
b) net long 6 (total position)
c) All of the
PnL would be shows as ‘unrealized’.
i.e., PnL is considered ‘realized’ (done and in the past) or
‘unrealized’ (still in the future).
So what you
what in the close out process is
1) To reduce
the number of active trades. In this
case, that would be just Deal# 100001 from our example above and
2) to count $4000 as realized PnL.
So let’s think
about how this would work…
We need to
introduce the concept for a CTRM system of a Futures Trade having 2 different
positions (quantities). There is the original
traded quantity. And then a second
position that is based on what is still active.
You can not just modify the original traded quantity (in a
closeout). Why? Well… for one thing… broker fees are based on
original traded quantity. If a broker charges
$3/lot for your original buy 10 trades, you still owe them $30 ($3 * 10) even
if you did a closeout. So somewhere in the
CTRM System, you need to still have the original traded 10 lots. There are other reasons, but the point is…
you need it.
Risk and MTM for going forward, need to be based on the active
position (remaining).
Which you
would have after a closeout process of:
Deal#: 100001:
Original Traded Position:
+10 Remaining Active: +6
Deal#: 100002:
Original Traded Position: -4
Remaining Active: 0
Next concept…
What you want
is a way to mark deal 100002 as ‘fully closed out’. And stop including it in your EOD
calculations (to save time and space).
Keep in mind that from the Exchange’s point of view, this trade is
‘gone’. Dec-2022 NYMEX CL contracts are
‘fungible’, so there is literally no -6 lot trade anymore. It went ‘poof’.
Now…. Keep in mind that for a
OTC trade (over the counter) you can’t do close outs. A buy and a sell ever for the same party have
certain credit risk things and so on.
Even if the counterparty goes bankrupt, without a legal netting
agreement in place, you might still need to pay them (for one of the two trades)
even if they can’t afford to pay you (for the other).
Note: At a firm with a high volume trading, they
might have 10,000 Dec-2022 NYMEX CL trades!
That would closeout down to potentially just one trade, a buy or a sell.
So it can make a real difference to help
with performance.
Example 2) The prior example, Example #1, was the simplest example. Let’s make it a bit harder and more realistic:
Day 1, Buy 10
lots of Dec-22 NYMEX CL at $80/BBL.
Deal# 101
Day 2, Sell 6
lots of Dec-22 NYMEX CL at $81/BBL. Deal# 102
Also on Day 2, Sell 6 lots of Dec-22
NYMEX CL at $82/BBL. Deal 103
Do you see the
problem? The problem is: you could close
out two ways:
Way #1) Buy 10
@ $80 nets out against 6 lots @ $81 and 4 lots @ $82
OR
Way #2) Buy 10
@ $80 nets out against just four lots @ $81 and the remaining 6 lots @ $82
So while the
total position remains a net (post closeout) at -1 lots…
the realized PnL would be different depending on which of the two about ways
you go. Also, you’ll either be left with
the -2 lots at a sell price of $81 or at a sell price of $82.
‘FIFO’ and ‘LIFO’
FIFO = First
in, First Out
LIFO = Last
in, First Out
Way #1 was
done using ‘FIFO’. Way #2 was done using
‘LIFO’
Even doing
FIFO and LIFO in a CTRM System creates challenges. What are you going to use to determined which trade was first for the point of view of
FIFO. You going to use
the time stamp on when the trade was booked into the CTRM System? Are you
going to use the trade time as reported by the exchange? As a reminder, we are already assuming the
trade date is the same.
There is no
perfect solution… so
in addition to FIFO and LIFO, you also need (i.e., a CTRM System needs) to
support a Custom closeout process..
a) Where this
could be done in code based on a client’s own rules or
b) Manually.. i.e., users could select which specific trades to be
closed out.
Though in
general, the closeout process is something that should be run automatically
each day.
Introduction to
CTRM
Click on this
link for a great introduction to CTRM software: Introduction to CTRM Software