A Physicist on Wall Street (ppt)

APhysicistonWallStreetJohnKraneThirdMillenniumTradingDowntownChicagoIdon’tactuallyworkonWallStreet,but“APhysicistonVanBurenStreet”doesn’thavethesameringtoit…8September,2005JohnKrane–ThirdMillenniumTrading2PersonalBkgndUniversityofSouthDakotazB.S.Bus.Admin.–Management…plusMath,Philosophy,Chemistry,Music,Economics…foundPhysicszB.SPhysicsUniversityofNebraska--LincolnzM.S.Physics,minorMathematicszPh.D.Physics,“TheRatioofInclusiveJetCrossSectionsatsqrt(s)=630and1800GeV”,plusWcrosssectionat630GeVzGSA1996-97IowaStateUniversityzPitfightingzGlobalTrackingcode(kalman/root/C++)zQCDGroupConvenorzjetalgorithmwork(MatthaisToennesmann)zNeutrinoMag.Moment(FritzDeJongh)zYPP2000-01z8yearstotalatFNALσW,Z�B(nb)√s(TeV)pp_→W+Xpp_→Z+XDØ(e)at630GeVDØ(e)DØ(μ)CDF(e)CDF(μ)UA1UA210-110.30.40.50.60.70.80.9123411.52DØDataRatioofScaledCrossSections(√s=630GeV/√s=1800GeV)CTEQ4HJμ=ET/2CTEQ4Mμ=ET/2CTEQ3Mμ=ET/2MRSTμ=ET/20.10.20.30.4JetXTCTEQ3Mμ=2ETCTEQ3Mμ=ETCTEQ3Mμ=ET/2CTEQ3Mμ=ET/411.52Givemeanalysisorgivemedeath!JohnKrane–ThirdMillenniumTrading3KalmanFiltervs.ParticleFilterzStandardKalmanfilter–Gaussianerrors,linearproblem–ExtendedKalmanFilter–Gaussianerrors,non-linearproblem(Taylor)–“Unscented”KalmanFilter–Gaussianerrors,non-linearproblem(coordinatetransformation)zParticleFilter–non-Gaussianerrors!(aMonteCarlotechnique)Bytheway…KalmanassumesPositionprobabilityisreallycf:“TheUnscentedParticleFilter”,vanderMerwe,Doucet,Freitas,WanTruepathBestfit…toobadit’simpossible!JohnKrane–ThirdMillenniumTrading4Whatisa“Quant”?zFundamentalFinancialAnalyst:Price/Earningsratios,globaleconomy,demandforproducts–MSNBC–FinancialreportscompanybycompanyzQuantitativeFinancialAnalyst:largedatasetsofhistoricalprices,etc,andstatisticalmodels–Datamining,patternrecognition,analysiszTechnicalAnalyst:movingaveragetrendlines,Elliotwavetheory,visualpatternsinpricing(“cupandbowl”,“eveningstar”)–Generallynotwell-foundedinstatisticsJohnKrane–ThirdMillenniumTrading5ThirdMillenniumTradingzMarketMakerYouwanttosell1000optionscontracts,webuythematthebidprice.Theywanttobuy1000contracts,wesellthemattheaskprice.Onaverage,amarketmakercollectsthebid/askspreadandhasnomarketrisk.Theyarepaidtoprovideliquidity(likeeBaydoesforgaragesales)zProprietaryTradingTradestomakemoneyfromowningorshortingtheinstruments.CanacquirepositioninthecourseofMM-ing.TMT:3BigBosses5-15FloorTraders5Prop.Trad.Desk+me,Dennis,MarkJohnKrane–ThirdMillenniumTrading6Stocks(Equities)zDerivevaluefrom–Oldschool:thesizeandlikelihoodofdividendpayment–Newschool:fromacompany’s(perceived)worthzCanbuythem(“golong”)orsellthem(“goshort”)Cansellstockwithoutactuallyowningit,butyoumustprovidecollateralinanaccountzPairstrading:golongandshortintwoclosely-relatedstocks–Iftheentiremarketunexpectedlylosesvalue,bothstocksmovesimilarlyandyouareprotected–Essentially,youaremakingabetonmean-reversionzBaskettrading:generalizationofpairstrading–per/stockcostscanhurtprofitsallthesestockconceptsapplytootherinstrumentsJohnKrane–ThirdMillenniumTrading7ModelsforStockPricesPricesareatimeseries(fractionaldailyσ=1%)modeledwith:autoregression,nearestneighbor,min/max,voodoo→hardtobeattheRandomWalkModel(futureprice=currentprice+ε)Histo:actual30-secpricefora3-stockbasketYellowblocks:actual20-minaveragepriceDots:Amass-and-springmodelThemoreaggressivethemodel,thebiggerthemistakesatmarketreversals!Randomwalkdoesbetterthanthismodel+++=−−−332211ttttSaSaSaSExampleofautoregression:Fibonaccinumbersanyone?oranyothertimeseries…JohnKrane–ThirdMillenniumTrading8SomedetailszAtradingcompanyisallowedtoprovidelessmoneythanthestockvalue(2:1leverage)…requiredwhethershortorlongzTradingrulesforrobots:Buy/Sellsignal,stop-loss,profit-takesignal,chicken-out,time-limitzHavetobeat40%/yearROI…mostofmyattemptswithstockscouldnotovercomecosts!→hardtopredictdirectionofshort-termpricemovesCosts:commission,bid/askspread,usu.2.5¢/shareThuswedon’ttradestocksforprofit!JohnKrane–ThirdMillenniumTrading9FutureszAstandardizedcontracttobuyorsellgoodsatasetpriceE.g.:40,000lbslivehogs@$47/100lbsinMarchzAgoodwaytoremoveuncertaintyforfarmerszSpeculatorsdon’tactuallyhavetobuythegoods,insteadjustsellbeforeexpiry…anybodywant40,000lbsbutter?zCanalsogoshort=agreetoselltheminthefuturewithoutowningthemnowzOil,gasoline,heatingoil,gold,platinum,silver,copper,wheat,cheese,milk,ureaCosts/contract:~$10/commis+$30bid/ask+20%marginJohnKrane–ThirdMillenniumTrading10StockOptions…akindofinsurancezFor$5,yougetacontractallowingpurchaseof100sharesofXat$K/shareinZmonths(canalsogoshortofcourse)zAfterZmonths,iftheprice$Sishigherthan$K,you“exercisetheoption”andpocket$(S-K)*100“cashsettlement”zIftheprice$Sislessthan$K,lettheoptionexpireandyouonlywaste$5Kisthe“strikeprice”Thecontractfinished“inthemoney”Thecontractfinished“outofthemoney”AmericanoptionsallowearlyexerciseJohnKrane–ThirdMillenniumTrading11AlittleStochasticCalculuszAssumestockpricesfollowgeometricBrownianmotion:zTheexpectationofthestockpricedistributionislognormal(i.e.,Ln(S)isGaussian)z1973FischerBlack,MyronScholes,RobertMertonpublish(willwin“Nobel”prizeforEconomics