Margin To Equity - Futures portfolios

Discussions about Money Management and Risk Control.
kianti
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Margin To Equity - Futures portfolios

I was looking at the Fact Sheet of one the best performing futures funds and I noticed between the risk statistics the typical margin to equity ratio.

I am using as a guide for development and backtesting of my trading systems the Veritrader User Guide and I noticed that this ratio is not included.

As a measure of risk I use c.f.:

Open Risk.............................The (dollar) distance from the current price to the closest stop, for all open positions. It is based on the assumption that all open positions
will be exited at their current designated stops (though some or all of
these positions may prove profitable in the future).

Closed Risk..........................The (dollar) distance from the entry price to the closest stop (either entry or trailing), for all open positions. If the trailing stop is profitable
then the closed risk on a position is zero.

Nassim Taleb also defines risk in a very similar way, distance between entry and stop-loss plus slippage.

I am trying to find some answers.
Letâ€™s say the margin on Natural Gas is \$5,000 instead of \$10,000, does it make any difference to my risk?
What happen to my risk if I post margin in Treasuries?
Is it margin-to-equity another way to describe the Max Units number or Portfolio Heat ?

Any input and help on this subject is very welcome.

Best regards, as ever
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Ted Annemann
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Suppose that your trading account equity is \$1.5 million. Suppose that you are currently long 2 contracts of April04 Natural Gas. Suppose your exit stoploss is at 4.780 and yesterday's close was 5.603. This means your risk on the trade is 0.823 points (\$8,230) per contract, or \$16,460 overall. Slightly less than 1.1 percent of equity.

Now suppose that the exchange cuts the margin requirement for Natural Gas in half, today, while you're in the middle of a trade. How do you react to this event? What will you do, and why?
• reverse and go short?
• double your position at the next possible moment?
• do nothing?
• place a limit order to double your position at the original trade entry price?
• cut your position in half at the next possible moment?
• place a stop order to cut your position in half, one tick beyond the highest high that occurred during this trade?
• withdraw \$8,630 from the account?
• add \$8,630 to the account?
• buy \$8,630 worth of put options to protect the long position?
• et cetera

kianti
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I wouldn't do anything because my exit or stop-loss should predefined before entering every trade.
Margins are linked to market volatility and if the Clearing House lowers the margins usually volatility is decreasing.
I could consider lowering my exposure, i.e. selling 1 lot, if the margin increases dramatically.
Lower margin will be taken into account the next trade, I could probably trade another contract, if the lower margin requirement is due to a lower market volatility.

thanks

Ted Annemann
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I would do nothing. The event has not changed the price of Natural Gas and I trade based on price. It hasn't change my entry price or my stoploss price (or the contract size / dollars-per-minumum-tick), so it hasn't changed my risk. As far as I'm concerned this event has no effect on my Natural Gas trade.

Dean Hoffman
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However, since margin is typically a function of volatility (risk) then the argument could be made that two systems with identical performances still have underlying differences in potential risk if one was using more margin on average to achieve the same return. Basically you could say that the one system had more volatility exposure to achieve the same return.

I find that the more margin a system is using in testing the higher the standard deviation in performance. You may end at the same place, but get there much differently. Personally I like to use average margin requirements when doing comparative types of studies. For example, return on average margin requirements as opposed to return on initial equity.

Dean Hoffman

kianti
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Or maybe the margin-to-equity is just a synthetic indicator to define the so-called timid/bold trader: timid trader uses a lower margin-to-equity ratio, the bold trader uses a higher margin-to-equity ratio.

Also margin-to-equity ratio alone does not tell a lot about diversification, I could have the 20% margin-to-equity all in Natural Gas or spread in 20 different positions. In the case above 1% max risk per trade is given.

A worst case scenario measure could be more appropriate, like max number of open position x initial risk% or open risk%.

Bruce
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Is there a way to know how much margin we are using with VeriTrader?

Forum Mgmnt
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Bruce,

There is a daily equity log which is in the Results directory. You can find the running margin equity in this file for each day in the test.

- Forum Mgmnt

P.S. We will probably add Margin to Equity just because many fund allocators look at it. I don't think it is that useful since margin is just a rough proxy for the relative dollary volatility of each of the markets. There are other better ways of looking at aggregate risk.

kianti
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I think the same about margin-to-equity, but if I want to present some simulated performance I'll be asked about this ratio I guess; it makes sense maybe for the last two years but not for ten years ago.

I'd rather use for backtesting a margin adjusted to volatility; margin for Crude Oil ten years ago I guess is different from today's margin.

Again, Crude Oil and other energy contracts are giving me some thougths; I've been using CSI data for backtesting and as a result of cost of carry, Crude Oil prices are negative back in time. Am I missing somehting?

Other data providers use the same method? What are the differences, especially in real-trading.

best regards, as ever

Forum Mgmnt
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Kianti,

I wish the CME's SPAN algorithm wasn't proprietary as that seems to be used by many/most of the futures brokers to determine margins dynamically based on volatility and price (and expiration for options).

See: http://www.cme.com/clr/rmspan/rmspan/intro1155.html

We could try and come up with a proxy for this, an algorithm that behave similarly. Does anyone have any SPAN margin history for a given commodity or access to this?

SPAN is nice because it actually gives you credit for offsetting risk positions like spreads or covered options.

- Forum Mgmnt

MarkH
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kianti -

CSI's backadjusting does generate negative numbers in the past time series for crude (and other commodities as well). There is a backadjusting option that, if selected, will add a fixed amount to the entire data series to eliminate the negative numbers. This means that the current prices in the series will be the actual prices plus the added fixed amount. For example, in my data series for crude, 30.00 is added, resulting in a current price in the 60's.

This technique eliminates the backtesting problem of having negative numbers in the data series without affecting the relative price movements measured by backadusted continuous contracts.

Mark

Forum Mgmnt
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VeriTrader can handle the negative data.

It adds a number to the prices internally and then adjusts for this when charting or displaying trade prices so the prices match the data file.

The negative numbers may seem weird but they are reflective of what would have happened had you rolled an open contract on the date specified by the particular roll settings you choose.

- Forum Mgmnt

DPH
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Forum Mgmnt wrote:Kianti,

I wish the CME's SPAN algorithm wasn't proprietary as that seems to be used by many/most of the futures brokers to determine margins dynamically based on volatility and price (and expiration for options).

See: http://www.cme.com/clr/rmspan/rmspan/intro1155.html

We could try and come up with a proxy for this, an algorithm that behave similarly. Does anyone have any SPAN margin history for a given commodity or access to this?

SPAN is nice because it actually gives you credit for offsetting risk positions like spreads or covered options.

- Forum Mgmnt
This looks interesting: Syncova Margin

From their promotional piece:
Until now, funds trading in Commodities and Financial Futures contracts could only receive SPAN margin reports from their counterparties, leaving them without transparency into calculations, and unable to perform What-If testing or reconcile with their counterparties.

Syncova Margin for Futures is the only solution available that enables fund managers and traders to dynamically calculate margin requirements for commodity and financial futures and options.

Lee MacFarlane
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