Introduction to Exchanges

Chris Welty

Walleye Trading

Who is this guy?

Walleye Trading

Hedge fund in Wayzata Quantitative focus ~35 employees

Exchanges

What they are Growth Quantitative Finance

History

1602 Amsterdam Stock Exchange 1730 Dojima Rice Exchange 1973 Chicago Board Options Exchange

Why trade on an exchange?

Standardization Liquidity Information Credit Efficiency

Executing a trade

Increasing Computerization

Match Buyers and Sellers

Who Does What

Customer Broker Exchange

MarketMaker

Broker

Accepts orders Executes orders Custodian Credit intermediation

Market Maker

Provide prices Provide liquidity Sometimes, stabilize market

Market Stabilization

NYSE Specialist Japanese Price limits Position limits

Increasing Quantitative Trading

Stocks Foreign Exchange Futures Options

Leads to massive growth

US Equity Options Volume

0

2

4

6

8

10

12

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

mil

lio

ns

of

co

ntr

ac

ts p

er

da

y

NYSE Volume

NYSE volume ($ Trillion)

0

5

10

15

20

25

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Market Growth

Reduced commissions Penny pricing Quantitative trading

Quantitative Finance

Option Modeling Automated Trading

Black-Scholes Model

Useful Not Practical

Black-Scholes Price

0

5

10

15

20

25

30

35

40

45

50

60 70 80 90 100 110 120 130 140

Black-Scholes Delta

0.0

0.2

0.4

0.6

0.8

1.0

1.2

60 70 80 90 100 110 120 130 140

Gamma

0.000

0.005

0.010

0.015

0.020

0.025

0.030

0.035

60 70 80 90 100 110 120 130 140

Rho (interest rate risk)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

60 70 80 90 100 110 120 130 140

Model Enhancements

Discrete dividends Different interest rates Variable volatility Smile Term structure Proprietary

Automated Trading

Algorithmic Execution Low-Frequency High-frequency

Algorithmic Execution

VWAP Minimize trading cost Reduce information leakage

Low Frequency Trading

Statistical Arbitrage Quantitative-based fundamental trading

High Frequency Trading

Hot new area Enabled by electronic trading Analysis of large data sets