SYLLABUS FOR F335 SECURITY TRADING AND MARKET MAKING, FALL 2011

Professor:	Craig W. Holden
Office:	BU 356C
Office Hours:	Mon-Wed, 12:00-2:00 or feel free to drop by any time!
Office Phone:	855-3383
E-Mail:	cholden@indiana.edu
Web Site:	www.kelley.iu.edu/cholden
Course Web Site:	oncourse.iu.edu

COURSE DESCRIPTION

Welcome to Security Trading and Market Making at Indiana University! For simplicity, most finance courses assume that securities trade in an idealized costless, frictionless world. In reality there are many frictions: bid-ask spreads, trade impact on price, brokerage commissions, quantity limitations, time delays, etc. This field of study is known as “market microstructure.” Microstructure has grown rapidly into one of the largest subdisciplines of finance and has had a profound impact on the real world. For example, one research study uncovered evidence of implicit collusion by NASDAQ dealers. This led to a class action lawsuit that was eventually settled when 30 brokerage firms paid a total of $1 billion in damages!

TEACHING STYLE

My approach to teaching involves four key features:

1. Assignment Preparation. Students are expected to read the assigned readings in advance and come to class ready to discuss them.

2. Class Participation. Students are expected to play a primary role in explaining the assigned readings, expressing their opinions, asking questions, and contributing to the class discussion. This “active learning” approach is student-centered, as opposed to professor-centered (where the professor simply lectures). I will frequently ask for voluntary contributions. I will frequently cold call on students to insure that everyone participates. Each time that I call on you, either as a volunteer or as a cold call, will count towards your class participation score. Attendance does not count.

3. Clicker Participation. I will frequently ask clicker questions to the entire class. All students are asked to respond to these questions using their clickers. Two points will be given for a correct response and one point for an incorrect response. Total clicker points will be scaled to fit the grading scale listed below. Let me know if you change clicker devices so that I can track you and give you credit. No allowance will be made for forgotten clickers, battery failures, or events (e.g., interviews, etc.) that might lead you to miss class. It is your responsibility to make sure that you have a functioning clicker device available for class and to accept any tradeoffs that you make in missing class. You are not allowed to submit clicker responses for a classmate. We will use clicker channel 14.

4. Learn By Doing. The best way to learn how to trade is to actually do (simulated) trades. The best way to learn how to present your ideas to others is to actually present your ideas to others. Therefore, you are expected to participate in two trading simulation projects and to do a group presentation of your trading ideas to the class.

COURSE OUTLINE

UNIT I: OVERVIEW

(1.) Aug 29, Introduction

· Harris, Pages 11-19

· PowerPoint: 01 Introduction

· Excel: NBBO Example

(2.) Aug 31, The Trading Industry

· Harris, Chapter 3

· PowerPoint: 02 The Trading Industry

· PDF: TAQ Project

UNIT II: HOW TRADING IS DONE

(3.) Sept 7, Orders

· Discuss Part 1 of the TAQ Project

· Harris, Chapter 4

· PowerPoint: 03 Orders

(4.) Sept 12, Market Structure Around The World

· Discuss Part 2 of the TAQ Project

· Harris, Chapter 5

· Jain #1, pages 2955, 2966, 2983

· Jain #2, pages 40-43

· PowerPoint: 04 Market Structure Around The World

UNIT III: SECURITY TRADER’S VIEWPOINT

(5.) Sept 14, Transaction Cost Measurement and Credit Suisse Tool

· Five Transaction Cost Measurement Methods

· Harris, Chapter 21

· Credit Suisse, pages 1-11

· PowerPoint: 05 Transaction Cost Measurement and Credit Suisse Tool

· Excel: Five Transaction Cost Measurement Methods

(6.) Sept 19, Algorithmic Trader Simulation and Low-Latency Trading

· Kickoff of Algorithmic Trader Simulation

· Hasbrouck and Saar, pages 1-4, 40-41, 48-55

· PowerPoint: 06 Algorithmic Trader Simulation and Low-Latency Trading

· PDF: F335 Fall 2011 Algorithmic Trader Simulation Instructions

· Excel: Algorithmic Trader Simulation Fall 2011

(7.) Sept 21, Limit Order Book Vs. Call Markets

· Harris, Chapter 6

· PowerPoint: 07 Limit Order Book Vs Call Markets

· Excel: LOB and Call Markets

(8.) Sept 26, The Impact of Recent Developments

· Angel, Harris, and Spatt, pages 1-20

· Hendershott and Moulton, pages 568-577, 581-582, 583

· Hendershott, Jones, and Menkveld, pages 1-4, 8-10, 12, 20-21

· PowerPoint: 08 The Impact of Recent Developments

(9.) Sept 28, Block Traders and Innovative Solutions

· Harris, Chapter 15

· Angel, Harris, and Spatt, pages 20-53

· “Price of Liquidity,” Traders Magazine

· PowerPoint: 09 Block Traders and Innovative Solutions

(10.) Oct 3, Day Traders

· Video: Risky Business: The Day Traders

· Discussion of Risky Business: The Day Traders

· “What it takes to trade,” CNN Money

· “What the regulators say,” CNN Money

· “Day trader decries new rule,” CNN Money

· NASAA Report, pages 1, 9-13, 44-46

· “Gambling Man,” Wall Street Journal Article

· Barber and Odean, pages 773-776

· PowerPoint: 10 Day Traders

(11.) Oct 5

· Algorithmic Trader Simulation Competition in BU 419

(12.) Oct 10

· Algorithmic Trader Simulation Presentations by Teams 1-5 and 11-15; All written reports are due

UNIT IV: MARKET MAKER’S VIEWPOINT

(13.) Oct 12, Market Manipulation and Insider Trading

· Video: Next: The Future Just Happened

· Discussion of Next: The Future Just Happened

· Lebed Posting

· Harris, Chapter 29

· Bhattacharya, Daouk, Jorgenson, and Kehr (2000), pages 69-70,73-74, 82-83, 93

· Bhattacharya and Daouk, pages 75, 80-84, 89, 92-93

· PowerPoint: 13 Market Manipulation and Insider Trading

(14.) Oct 17

· Midterm

(15.) Oct 19, Algorithmic Dealer Simulation and Specialist Execution Strategies

· Kickoff of Algorithmic Dealer Simulation

· PDF: F335 Fall 2011 Algorithmic Dealer Simulation Instructions

· PowerPoint: Algorithmic Dealer Simulation and Specialist Execution Strategies

· Excel: Algorithmic Dealer Simulation Fall 2011

· Excel: Specialist Strategies

(16.) Oct 24, Bid-Ask Spreads and PIN

· Harris, Chapter 14

· Easley, Kiefer, O'Hara and Paperman, pages 1405-1410, 1418, 1421

· PIN Sampler (Vega; Agudelo; Easley, Engle, O’Hara, and Wu; Easley, de Prado, and O'Hara)

· PowerPoint: 16 The Bid-Ask Spreads and PIN

· Excel: PIN Model Estimation, PIN Model Dynamics

(17.) Oct 26, Floor Traders and Brokers

· Video: Floored

· Discussion of Floored

· Harris, Chapter 7

· Harris, Hillary Clinton’s Futures Trading Profits

· Clinton, Living History, pages 86-87

· PowerPoint: 17 Floor Traders and Brokers

(18.) Oct 31, Arbitrageurs and Informed Traders

· Harris, Lecture 13 Arbitrage, pages 1-5

· Gagnon and Karolyi, page 60

· Gatev, Goetzmann, and Rouwenhorst, pages 797-799, 803-804, 807, 809, 812, 817

· Bowen, Hutchinson, and Sullivan, pages 31-35

· Harris, pages 222-229, 235

· PowerPoint: 18 Arbitrageurs and Informed Traders

UNIT V: REGULATOR’S VIEWPOINT

(19.) Nov 2, Short Selling, Lockups, and the Tobin Tax

· Ofek & Richardson, pages 1113-1116, 1127-1128

· Schultz, pages 351-352, 354, 358, 360, 370

· "Nasty, brutish and short," The Economist

· “Taxing the Speculators,” New York Times

· "A Transaction Tax Would Hurt All Investors," Wall Street Journal

· “EU proposes 0.1 percent financial transactions tax”

· Beber and Pagano, pages 1-4, figures 1-7, tables 1-2, 4

· PowerPoint: 19 Short Selling

(20.) Nov 7, Transparency and Individual Investors

· Bessembinder, Maxwell, and Venkataraman, pages 251-254, 268-269

· Edwards, Harris, and Piwowar, pages 1421-1423, 1437, 1441

· Barber and Odean, pages 785-788, 797, 799-800, 802, 804

· Barber, Lee, Liu, and Odean, pages 609-611, 614-615, 619, 621

· PowerPoint: 20 Transparency and Individual Investors

(21.) Nov 9, Crashes

· “Stocks Plunge As Rescue Plan Fails To Gain House Approval,” Wall Street Journal

· Harris, Chapter 28

· Roll, pages 19-26

· Shiller, Irrational Exuberance, pages 82-95

· “Repeating the 1920s?” Wall Street Journal

· “Market at a Crossroads,” Wall Street Journal

· “Time To Stand Tight,” Wall Street Journal

· Joint Preliminary Report on the Flash Crash, pages 11-15, 35, 46, 51, 54

· Joint Final Report on the Flash Crash, pages 1-8, 19-22, 24-26, 30, 33, 61, 88, 90, 94, 98, 100

· PowerPoint: 21 Crashes

(22.) Nov 14

· Algorithmic Dealer Simulation Competition in BU 419

(23.) Nov 16

· Algorithmic Dealer Simulation Presentations by Teams 6-10 and 16-20; All written reports are due

Thanksgiving Break

(24.) Nov 28, Deception and Bias

· Hanke and Hauser, pages 57-66, 76, 81-82

· Bhattacharya, Holden, and Jacobsen, pages 1-3, 7-10, 14-15

· Grinblatt and Keloharju, pages 549-556, 569, 574

· PowerPoint: 24 Deception and Bias

UNIT VI: COMPETITIVE EXCHANGE VIEWPOINT

(25.) Nov 30, Competitive Dynamics

· Biais and Green, pages 3-7, 40-41, 43-46, 50-51

· Mayhew, pages 931, 933-934, 948-949, 955

· Battalio, Hatch, and Jennings, pages 933-936, 944-945, 948-949, 952-953, 955

· PowerPoint: 25 Competitive Dynamics

(26.) Dec 5, Competing by Cross-Listing

· Doidge, Karolyi, and Stulz, pages 253-259, 267

· Moulton and Wei, pages 570-572, 575, 580, 587-588

· Fernandes and Ferreira, pages 216-218, 231-233

· PowerPoint: 26 Competition by Cross-Listing

(27.) Dec 7, Competing by Innovating

· Kavajecz and Keim, pages 465-472, 478, 480, 487

· Boehmer, Saar, and Yu, pages 783-787, 791, 793, 795, 801-802, 805-806

· Barclay and Hendershott #1, pages 1041, 1044-1045, 1047-1048, 1053

· Barclay and Hendershott #2, page 689

· PowerPoint: 27 Competiting by Innovating

(28.) Final Exam

· 2:30 Class: Fri, Dec 16, 5:00-7:00 p.m., BU 213 or Wed, Dec 14, 9:00-11:00 am, BU 427

· 4:00 Class: Mon, Dec 12, 2:45 a.m.-4:45 p.m., BU 213 or Wed, Dec 14, 9:00-11:00 am, BU 427

READINGS

· Trading and Exchanges by Professor Larry Harris. It available as hardcover book or as electronic book for any computer, tablet, or smartphone. It is available as a Kindle book to buy or to rent from Amazon.com, as a NookBook from BarnesAndNoble.com, and as a ebook from bookdepository.com.

· A collection of selected academic and practitioner readings can be downloaded as a PDF file from OnCourse.

GRADING

Grading is done on a relative (not absolute) basis. Following standard finance department policy, the average GPA will fall between 2.70 and 3.00. A detailed break-down of points earned-to-date will be posted on the PostEm tab of OnCourse on two occasions: (1) when the midterm is returned (including a indicative grade for the first half of the course) and (2) shortly after the last class session, which will be prior to finals week. The course grade is based on:

Item	Points	Percent	Kick Off	Due Date
Class participation · Verbal participation in first half · Verbal participation in second half	30 points 30 points	6.25%  6.25%	----	----
Clicker Participation · Clicker participation in first half · Clicker participation in second half	30 points 30 points	6.25% 6.25%	----	----
Algorithmic Trader Simulation · Algo. Trader Sim. Competition · Algo. Trader Sim. Written Report	15 points 30 points	3.125% 6.25%	Sept 19	Oct 10
Algorithmic Dealer Simulation · Algo. Dealer Sim. Competition · Algo. Dealer Sim. Written Report	15 points 30 points	3.125% 6.25%	Oct 19	Nov 16
Group Presentation	30 points	6.25%	----	Oct 10 or Nov 16
Midterm	120 points	25%	----	Oct 17
Final Exam	120 points	25%	----	2:30: Dec 14, 16 4:00: Dec 12, 14
Total Points	480 points	100%	----	----

POLICIES

1. In the first two class sessions we will be evolving towards permanent seats with due consideration for the usual course adds and drops. In class 3, I will ask you to sign-up for a permanent seat for the rest of the semester. Permanent seats assist me quite a bit in associating faces and names.

2. At the end of each team project, I will ask for confidential peer evaluations of individual contributions to the team output. Individuals who have contributed significantly less than their teammates will be penalized. The purpose of the peer evaluations is to provide direct incentives for individual contributions to the team output.

3. Students are expected to be ready for class at the scheduled time. Classes will start class on time and late arrivals will be frowned on.

GROUP PROJECTS

ALGORITHMIC TRADER SIMULATION

Students will be organized into teams and each team will download the Algorithmic Trader Simulation, which runs on the Excel simulation add-in program @RISK. Teams can analyze a variety of security trading problems. Each problem requests that a certain number of shares be purchased within a particular timeframe. In implementing this request, the general goal is to minimize the utility cost of trading = total cost of trading on shares purchased + (penalty coefficient) * (shares not purchased within the timeframe). Teams will use their own intuition to search for an optimal algorithmic order submission strategy (order type, size, and price, pattern over time, etc.) for each problem. Security trading problems can vary based on security trader type, degree of trader patience, magnitude of trader penalty cost for execution failure, performance metric, and stock that is being traded. Each team’s order submission strategies will be put to the test in a live, head-to-head, security trading competition and each team will summarize their security trader strategies in a written report. Teams 1-5 and 11-15 will present their strategies in class.

ALGORITHMIC DEALER SIMULATION

Students will be organized into teams and each team will download the Algorithmic Dealer Simulation, which runs on the Excel simulation add-in program @RISK. Teams can analyze a variety of dealer problems in a pure dealer market (similar to (pre-reform) NASDAQ or the London Stock Exchange). Teams will manage the strategy of one dealer in competition with other dealers. The overall goal is to maximize profits and control inventory risk. Teams will search for an optimal algorithmic dealer strategy (quote prices and depths, execute large orders in full or partial, adjust to order arrival patterns, adjust to information arrival, and manage inventory) for each problem. Dealer problems can vary based on dealer risk aversion, order processing costs, volume, stock, and overnight volatility. Each team’s dealer strategies will be put to the test in a live, head-to-head, dealer competition and each team will summarize their dealer strategies in a written report. Teams 6-10 and 16-20 will present their strategies in class.

UNDERGRADUATE PROGRAM LEARNING GOALS

F335 contributes to achieving the following undergraduate program learning goals: (1) quantitative analysis and modeling, (2) global awareness, (3) critical thinking and decision making, (4) ethical reasoning, (5) communication, and (6) team membership and leadership. The course teaches quantitative analysis and modeling by teaching how to compute the quoted spread, effective spread, realized spread, NBBO, five transaction cost measurement methods, how orders execute in limit order book vs. call markets, the PIN model, and specialist execution strategies. The course teaches global awareness by teaching about the global trading industry, market structure around the world, insider trading laws and enforcement around the world, global stock market crashes, short selling restrictions around the world, studies using data from the UK, Taiwan, and Finland, and international cross-listing. The course teaches critical thinking and decision making through two trading simulations that are wide-open projects, such that students must formulate their own trading strategies, must choose what trading problems to analyze, and must synthesize general principles of trading and market making. This course teaches ethical reasoning through the discussion of insider trading, market manipulation, broker exploitation of clients, day trading firm exploitation of naïve clients, and deceptive stock spam emails. The course teaches communications by requiring both written reports and PowerPoint presentations. The course teaches team membership and leadership through two major group projects.

APPENDIX

Undergraduate Program Learning Goals

Learning Goal 1: An Integrative Point of View

Graduates of the Kelley School of Business Undergraduate Program will be able to evaluate and make business decisions from an integrative point of view, one that reflects an understanding of mutually interdependent relationships among competitive and environmental conditions, organizational resources, and the major functional areas of a business enterprise.

Learning Goal 2: Ethical Reasoning

Graduates of the Kelley School of Business Undergraduate Program will be able to recognize ethical issues, demonstrate familiarity with alternative frameworks for ethical reasoning, and discern tradeoffs and implications of employing different ethical frames of reference when making business decisions.

Learning Goals 3: Critical Thinking & Decision Making

Graduates of the Kelley School of Business Undergraduate Program will be able to use a variety of research methodologies to identify and critically evaluate implications of business decisions for organizational stakeholders (e.g., customers, colleagues, employees, stockholders, suppliers, foreign governments, communities, cultures, regulatory agencies) and the natural environment.

Learning Goal 4: Communication

Graduates of the Kelley School of Business Undergraduate Program will be able to communicate effectively in a wide variety of business settings (e.g., live, virtual, synchronous and asynchronous), employing multiple mediums of communications (e.g., written, oral and visual).

Learning Goal 5: Quantitative Analysis and Modeling

Graduates of the Kelley School of Business Undergraduate Program will be able systematically apply tools of quantitative analysis and modeling to make recommendations and business decisions.

Learning Goals 6: Team Membership & Leadership

Graduates of the Kelley School of Business Undergraduate Program will be able to collaborate productively with others, functioning effectively as both members and leaders of teams.

Learning Goal 7: Respect, Inclusiveness & Valuing People

Graduates of the Kelley School of Business Undergraduate Program will be able to create and sustain personal and work environments that are respectful and inclusive, valuing the contributions of all persons.

Learning Goal 8: Personal and Professional Development

Graduates of the Kelley School of Business Undergraduate Program will be prepared to become the “authors” of their own futures, make informed and deliberate choices about personal and professional development, assume responsibility for their decisions, take pride in excellence, contribute to community, and demonstrate college-level mastery of the skills needed for pursuing and managing a career as a business professional.

Learning Goal 9: Global Awareness

Graduates of the Kelley School of Business Undergraduate Program will be conversant with major economic, social, political, and technological trends and conditions influencing foreign investment and development of the global economy and demonstrate an understanding of the cultural, interpersonal and analytical competencies required for engaging in global business activities.

Learning Goal 10: Innovation and Creativity

Graduates of the Kelley School of Business Undergraduate Program will know how to respond to the need for innovation or creativity by engaging in ongoing learning, broadening their points of view, exploring cross-contextual links, and consulting with others.