What is a smart trade?
A smart trade is tailoring a hedge for any single security trade by removing any unwanted factor bets, targeting sector requirements, and maximizing the alpha in the trade.
Similar to paired trading, smart trading shorts a basket of securities on a long trade and vice versa. Smart trading comes to life through a simplified basket construction workflow:
- Create a research topic to organize your smart trade experiments
- Quickly setup your trade
- Select a universe of securities
- Finalize your experiment by iterating through various factor rules to achieve your ideal level of alpha
With these four steps, you’ll be creating smart trades in seconds! Follow along as we setup a smart trade for MSFT.
Step 1: Research Topics
To help organize various smart trade iterations, the Omega Point platform is introducing a new resource type - research topics. With research topics, you can neatly create as many smart trade experiments for a particular “reference security.”
Research topics are created from the home screen / resources screen and allow you to search for any security within the risk model universe, in this case we select MSFT as the reference security for the research topic and smart trade experiments.
Step 2: Creating a Smart Trade Experiment & Trade setup
Once a research topic has been created, adding a smart trade is as simple as adding an experiment to the topic page.
Click on the Smart trade option to get started and configure the trade parameters:
- Reference Instrument
This is set through the research topic and is currently limited to a single security
- Risk model
Select which risk model will be used in calculating risk, exposure
- Trade date
The date of the experiment, simulating the date this trade would be made
- Trade size
How much the reference instrument is being traded, positive for long, negative for a short trade.
Step 3: Select Universe
Using Omega Point’s security screener, it is easy to filter down the universe of securities as potential hedges to include in the basket. For this smart trade, we select securities that are in SPY, have an average daily volume of greater than $100M, and are not MSFT.
An in-depth guide to all the features in this select universe screen can be found in the Security Search article.
This universe can be further refined to target specific risk, factor exposures, or filter out based on sector or market cap.
Click next to create a preliminary smart trade.
Step 4: Iterate on rules and finalize experiment
In this final step, the reference security, the constructed basket, and the combined smart trade are displayed side-by-side for quick comparison, including seeing the impact of the smart trade on the specific risk of this trade.
From the left-panel, a summary report displays key metrics on the basket positions. In this panel, it is also possible to review and remove positions in the basket, as well as make the smart trade adhere to specific rules:
- Basket as % of Trade Size
This rule lets you change the size of the basket, as a function of the trade size value you input in step 1.
The default size of the basket is set to -100%, where for example, a $10M trade would generate a -$10M basket, and -$10M trade would generate a $10M basket.
In this rule, you can change the size of the basket to be anywhere between 0 - -100% of the trade.
- Max Trade as % of ADV
Limits trading into any basket position by its liquidity, where ADV is defined as the 20-day average of daily volume in $ USD.
Meaning % of ADV is calculated as $ trade / ADV. To view the positions as a % of their ADV, click on the 'summary' tab and click on "Top 10 by Position Size" to also view "Top 10 by % ADV."
- Max Concentration of Basket Constituents
This sets an upper bound limit on the basket position weights, as seen by clicking on the "Positions" tab. The Max Concentration will limit these position weights relative to the denominator of the smart trade, taken to be the total GMV of the trade + basket.
- Smart Trade Rules
More information immediately below
Smart Trade Rules
These rules allow you to search for any factor & target a specific range that the smart trade should adhere to.
Smart trades can be further enhanced by uploading your signals to the Omega Point platform. More information about your signals can be viewed in this article.
We hope that this basket construction workflow makes it easy to create smart trades so you can continue to focus on your alpha!
Comparing smart trades to simple hedges
The research topic feature is not only a place to organize smart trade experiments, but to also help compare smart trade experiments to other hedging options.
When a research topic column is loaded with a single security, there is an option to set a hedge on that security. A dialog appears that controls finding any single security to act as a naive hedge.
Once set, the research topic column is updated with your hedging option, enabling a more apples-to-apples comparison between smart trades and this other hedge option.