How often do you recompute your hedge ratio and and the period you use to compute the hedge ratio? With the ratio change would is comparing to option delta adjustment?
I think you are spot on with regards to comparing the hedge ratio for a futures spread to an options delta adjustment. The hedge ratio changing depends upon the volatility of the instruments used. For fixed income spreads where the futures contracts are fungible, the underlying cash securities and the on-the-run "cheapest to deliver" instruments affect the hedge ratios as well. For example, the Sept 2012 NOB is a 2:1 ratio, where previously the ratios were typically like 1.667:1 for a very long time.
Is using hedge ratio favor compare to using none of the ratio? The ratio is historical and does not represent forward ratio. If the period is too little or the volatility changes a lot the ratio changes frequently and you may find you are constantly adjusting your trade according to the ratio
hi Bone have a question about how to margin such spreads. Are there any brokers/shops which allows margin credits for using such highly correlated spread strategies? pls name a few. thanks
I was wondering about margin on something like the Rio Tinto/Copper spread above also. If you clear with a firm like Vision that does equities and futures can they work out margin credits on those types of custom instrument spreads?
For spreads to get margined without a published exchange credit ( like a stock or a basket of equities versus a futures contract ) you will need an omnibus account at a more sophisiticated clearing firm whose risk department understands and has seen these types of strategies - which means prime brokerage. Most hedge funds utilize prime brokerage services. Most Prime Brokerage accounts are offered by Investment Banks to their hedge fund clientele. PB will offer their clients access to OTC Swaps and ISDA clearing, physical markets, and custom margining like we have discussed. I used to use them for some rather exotic OTC heat rate spreads in the US Power Market.
Not unless you are trading intramarket spreads like CL U2 vs CL Z2, or GE Z2 vs GE Z3. Those are all traded in a 1:1 ratio ( which I am assuming satisfies your description of "none of the ratio"). If you are spreading two different instruments, each with a different volatility and each with a different tic valuation, ( usually a synthetic intermarket combination, such as Gold versus Platinum or ICE Gas/Oil versus Nymex Heating Oil ) then you want to use a hedge ratio in order to reduce as much as practical 'tail risk' and delta directionality. The idea is to profit from the divergence or convergence in the spread differential itself, and to insulate yourself as much as practical from the turbulence of broad market movements. Yes, since I cannot predict the future, the only thing I can account for is what I already know to be recorded fact - hence, all I have to go on is historical data. I do not personally believe that occasionally adjusting a hedge ratio to be a worse dilemma than using a common technical study indicator to predict a singular instrument's future directionality.
The reason for the overlays is to illustrate the microstructure of the interday relationship between Rio Tinto share price and the price of the Copper futures contract.