SYLLABUS FOR F335 SECURITY TRADING AND MARKET MAKING – FALL 2013

 

Professor:

Craig W. Holden

Office:

HH 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 is an important subdiscipline 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. Clicker responses are individual. You are not allowed to consult or coordinate with others. You are not allowed to submit clicker responses for others. We will use clicker channel 35.

 

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: AN OVERVIEW OF TRADING AND MARKETS

 

(1.) Aug 26, Introduction

·      Hasbrouck, Chapters 1 and 2

·      PowerPoint: 01 Introduction

·      Excel: NBBO Example

 

(2.) Aug 28, Financial Markets

·      Teall, Sections, 2.1-2.6

·      PowerPoint: 02 Financial Markets

 

No class on Labor Day, Sept 2

 

(3.) Sept 4, Overview

·      Explain the TAQ Project

·      Johnson, Sections 1.1-1.3, 1.6, 1.8-1.10

·      PowerPoint: 03 Overview

·      PDF: F335 TAQ Project

 

(4.) Sept 9, Market Microstructure

·      Discuss the TAQ Project

·      Johnson, Chapter 2

·      PowerPoint: 04 Market Microstructure

 

(5.) Sept 11, World Markets

·      Johnson, Tables and Figures in Appendices A-F; Sections 3.4-3.6

·      PowerPoint: 05 World Markets

 

UNIT II: ALGORITHMIC TRADING AND DMA STRATEGIES

 

(6.) Sept 16, Orders

·      Johnson, Chapter 4

·      PowerPoint: 06 Orders

·      Excel: LOB and Call Markets

 

(7.) Sept 18, Algorithm Overview

·      Johnson, Chapter 5

·      PowerPoint: 07 Algorithm Overview

 

(8.) Sept 23, Transaction Costs

·      Johnson, Chapter 6

·      PowerPoint: 08 Transaction Costs

·      PDF: Transaction Cost Measures and Components

·      Excel: Transaction Cost Measures and Components

 

(9.) Sept 25, Algorithmic Trading Simulation and Low-Latency Trading

·      Kickoff of Algorithmic Trader Simulation

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

·      PowerPoint: 09 Algorithmic Trading Simulation and Low-Latency Trading

·      PDF: F335 Fall 2013 Algorithmic Trader Simulation Instructions

·      Excel: Algorithmic Trader Simulation Fall 2013

 

(10.) Sept 30, Optimal Trading Strategies

·         Johnson, Chapter 7

·         PowerPoint: 10 Optimal Trading Strategies

 

UNIT III: IMPLEMENTING TRADING STRATEGIES

 

(11.) Oct 2, Order Placement

·         Johnson, Chapter 8

·         PowerPoint: 11 Order Placement

 

(12.) Oct 7, Execution Tactics and Low-Latency Trading

·         Johnson, Chapter 9

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

·         PowerPoint: 12 Execution Tactics and Low-Latency Trading

 

UNIT IV: THE SELL SIDE’S VIEW

 

(13.) Oct 9, Market Manipulation and Insider Trading

·         Video Clips: Next: The Future Just Happened

·         Discussion of Next: The Future Just Happened

·         Lebed Posting

·         Harris, Chapter 29

·         Bhattacharya, Daouk, Jorgenson, and Kehr, 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 14, 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: 19 Floor Traders and Brokers

 

(15.) Oct 16

·         Algorithmic Trader Simulation Competition in HH 419

(16.) Oct 21

·      Midterm

 

(17.) Oct 23

·         Algorithmic Trader Simulation Presentations by Teams 1-4 and 11-14; All written reports are due

 

(18.) Oct 28, Algorithmic Dealer Simulation and Short Selling

·         Kickoff of Algorithmic Dealer Simulation

·         "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 transaction tax,” Reuters

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

·         PDF: F335 Fall 2011 Algorithmic Dealer Simulation Instructions

·         PowerPoint: 18 Algorithmic Dealer Simulation and Short Selling

·         Excel: Algorithmic Dealer Simulation Fall 2011

 

(19.) Oct 30, 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)

·      X-Trader Demo

·      PowerPoint: 14 The Bid-Ask Spreads and PIN

·      Excel: PIN Model Estimation, PIN Model Dynamics

 

(20.) Nov 4, 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: 20 Arbitrageurs and Informed Traders

 

UNIT V: CONCERNS ABOUT SECURITY TRADING

 

(21.) Nov 6, Ghost Exchange

·      Video Clips: Ghost Exchange

·      Discussion of Ghost Exchange

 

(22.) Nov 11, Concerns about Equity Trading

·         Angel, Harris, and Spatt

·         PowerPoint: 22 Concerns about Equity Trading

 

(23.) Nov 13, Concerns about Bond and Option Trading

·         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: 23 Concerns about Bond and Option Trading

 

(24.) Nov 18

·      Algorithmic Dealer Simulation Competition in HH 419

 

(25.) Nov 20

·      Algorithmic Dealer Simulation Presentations by Teams 5-8 and 15-18; All written reports are due

 

Thanksgiving Break

 

(26.) Dec 2, Deception and Behavioral Biases

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

·         Bhattacharya, Holden, and Jacobsen, pages 413-415, 419-422, 426-427

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

·         PowerPoint: 26 Deception and Behavioral Biases

 

(27.) Dec 4, 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, 57

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

·         PowerPoint: 27 Crashes

 

(28.) Dec 9, 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: 28 Transparency and Individual Investors

 

(29.) Dec 11, Day Traders

·         Video Clips: 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: 29 Day Traders

 

(30.) Final Exam

·         9:30 Class: Wed, Dec 18, 8:00-10:00 a.m., HH 201

·         11:15 Class: Wed, Dec 18, 5:00-7:00 p.m., HH 201

 

READINGS

 

·         Security Trading: Procedures and Principles, Draft Teaching Notes, by Joel Hasbrouck, download from OnCourse

 

·         Algorithmic Trading & DMA: An Introduction to direct access trading strategies, by Barry Johnson, published by 4Myeloma Press, by arrangement with the publisher it can be purchased at Amazon.com

 

·         A readings collection, download 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 25

 

Oct 23

Algorithmic Dealer Simulation

·         Algo. Dealer Sim. Competition

·         Algo. Dealer Sim. Written Report

  

15 points

30 points

 

3.125%

6.25%

 

Oct 28

 

Nov 20

Group Presentation

30 points

6.25%

----

Oct 10 or Nov 16

Midterm

120 points

25%

----

Oct 21

 

Final Exam

 

120 points

 

25%

 

----

 9:30: Dec 18, 8am

11:15: Dec 18, 5pm

Total Points

480 points

100%

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 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.

 

4.      Video cameras may be used to monitor the room during student assessment activities, including but not limited to, exams, tests, and quizzes.  Video recordings may be used to investigate or support disciplinary action.  All access to and use of video equipment and recordings will follow applicable IU policies.

 

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 1-4 and 11-14 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 5-8 and 15-18 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, NBBO, transaction cost measures and components, how orders execute in limit order book vs. call markets, and the PIN model. 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, and global stock market crashes. 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, 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.