CME Group Risk Management Handbook

JOHN W. LABUSZEWSKI is Managing Director of Research and Product Development at CME Group. Labuszewski came to CME from Nikko Securities International, where he was general manager of the asset management division. He had previously worked for Fenchurch Capital Management, Refco, and the Chicago Board of Trade. Labuszewski is coauthor of four previous industry-related texts. He earned an MBA from the University of Illinois. JOHN E. NYHOFF is Director of Financial Research and Product Development at CME Group. He has lectured extensively in the interest rate derivative product area, and has taught financial futures and options and related courses at DePaul University and several other Chicago-area colleges. Nyhoff is coauthor of two industry-related texts: Trading Options on Futures and Trading Financial Futures (both from Wiley). He holds a master's in financial economics from the University of Rochester, a master's in economics from Northern Illinois University, and a bachelor's degree in economics from DePaul University.RICHARD CO is Director of Financial Research and Product Development at CME Group. He joined CME in 1999. Dr. Co received a PhD in economics from the University of Chicago in 2000 and is a Chartered Financial Analyst.PAUL E. PETERSON is Director of Commodity Research and Product Development at CME Group. He joined CME in 1989. Before that, Peterson served as vice president, research, for Brock Associates from 1988 -1989; manager, education and marketing services, for the Chicago Board of Trade from 1986-1988; and manager, market analysis, for the American Farm Bureau Federation from 1983-1986. Peterson holds a PhD in agricultural economics from the University of Illinois and has authored a number of articles in professional journals and business/trade publications.CME Group is an international marketplace that brings together buyers and sellers on its trading floors and CME Globex around-the-clock electronic trading platform. CME Group operates leading derivatives exchanges including CME, Chicago Board of Trade, and NYMEX, offering futures contracts and options on futures, in diverse product areas including interest rates, stock indexes, foreign exchange, agricultural, energy, and metals.

• Foreword by Leo Melamed ixPrologue by Terry Duffy xiiiAcknowledgments xvIntroduction by Craig S. Donohue xviiCHAPTER 1 Futures Market Fundamentals 1What Is a Futures Contract? 2Overview of Popular Financial Futures Contracts 21Anatomy of a Futures Transaction 35Conclusion 41Notes 42CHAPTER 2 Order Entry and Execution Methodologies 43Open Outcry/Pit Trading 44Introduction of the CME Globex Platform 46Trade Matching Algorithms 50About Options Markets 69Ex-Pit Trading 73Conclusion 78Notes 79CHAPTER 3 Role of the Clearinghouse 80Financial Safeguards 81Financial Surveillance 89Default by a Clearing Member 91Resources Backing CME Group Clearing System 95Customer Protection 95Disaster Recovery and Business Continuity 96Rule Enforcement 96Financial and Regulatory Information Sharing 99Conclusion 100CHAPTER 4 Currency Futures: The First Financial Futures 101Evolution of Foreign ExchangeMarketplace 101Over-the-Counter Currency Trading Vehicles 106Exchange-Traded Currency Futures and Options 115Foreign Exchange Market Growth and Trends 130Conclusion 135Notes 136CHAPTER 5 Stock Index Futures: The First Financial Futures 137Mechanics of Stock Index Futures 137E-Minis versus Exchange-Traded Funds 142Pricing Stock Index Futures 147Spreading Stock Index Futures 152Hedging with Stock Index Futures 158Portable Alpha Strategies 163Conclusion 167Notes 168CHAPTER 6 Eurodollar Futures: Interest Rate Market Building Blocks 169Eurodollar Futures Market 169Speculating on Shape of Yield Curve 180Term Treasury/Eurodollar (TED) Spreads withFutures and Options 184Interest Rate Swap Market 194Growing Up Together 202Pricing Relationship 205Hedging Techniques 208Conclusion 215Technical Appendix: Complications and Shortcutsfor Pricing and Hedging Swaps 216Notes 229CHAPTER 7 Understanding U.S. Treasury Futures 231Coupon-Bearing Treasury Securities 231Treasury Futures Delivery Practices 238Measuring Risk of Coupon-Bearing Securities 252Risk Management with Treasury Futures 254Macro Hedging with Treasury Futures 262Hedging Corporates with Treasury Futures 266Trading the Yield Curve with Treasury Futures 269Conclusion 276Notes 277CHAPTER 8 Commodities: Backbone of the Futures Industry 279What Are Commodities? 280Grain Markets 293Livestock Markets 299Energy Products 315Precious Metals 327The Forward Curve 331Intermarket Commodity Spreading 342ClearPort Over-the-Counter Clearing Facility 347Conclusion 350Appendix: Major Commodity Market Specifications 351CHAPTER 9 Alternative Investment Market Fundamentals 368Weather 369Residential Housing Futures 379Economic Indicators 397Conclusion 399Notes 400CHAPTER 10 Fundamental Market Indicators 401Why These Indicators? 402Trading Volumes 404Volatility: Daily Net Change 407Volatility: Daily High-Low Range 408Conclusions 412Appendix: Economic Indicator Descriptions 412Notes 414CHAPTER 11 Technical Analysis Primer 416Why Technical Analysis? 416Interpreting Charts 422Elliott Wave Theory 443Intraday Trading Techniques 455Trend-Following Systems 459Conclusion 471CHAPTER 12 Fundamentals of Option Markets 472What Is an Option? 472Mathematical Option Pricing Models 481Historic and Implied Volatilities 494Measuring Option Performance 504Conclusion 513CHAPTER 13 Option Trading Strategies 515Option Spreads 515Horizontal Spreads 526Diagonal Spreads 532Comparing Verticals, Horizontals, and Diagonals 537Weighted Spreads 538Volatility-Driven Strategies 544Specialty Option Strategies 560Matching Strategy and Forecast 565Conclusion 566CHAPTER 14 Hedging with Options 568Baseline Futures Hedge 568Buying Protection with Puts 569Yield Enhancement with Calls 572In- and Out-of-the-Money Options 575Matching Strategy with Forecast 577Collar Strategy 578Delta-Neutral Hedge 579Conclusion 581About the Authors and Contributors 583Index 587