Implied Pricing for Fixed Income Derivatives

The implied pricing algorithm will contribute to improve MX market quality and liquidity by adding a new price discovery dimension. This algorithm is limited to individual CRA contracts, the options market (equity, ETF, currency and index options), and strategies. On August 19, 2013, we also activated the algorithm on CGZ, CGF and LGB. The price/time algorithm (FIFO) will be respected at all times within the context of the implied pricing market model whereby all regular orders (non implied) will always have price/time priority over implied orders.

Implied prices are disseminated through HSVF (High Speed Vendor Feed) for independent software vendors and data vendors that have developed the functionality. Contact your vendor for more information.

Should you require technical assistance or wish to carry out testing in our development environment, do not hesitate to contact our Technical Help Desk at 1-877-588-8489 or by email at samsupport@m-x.ca.

User-Defined Inter-Group Strategies for Futures and Options on Futures

Definitions

Regular orders
Orders routed by approved participants to the Montréal Exchange trading system.

Implied orders
Orders generated by the implied pricing algorithm (using regular orders) and registered in the order book by the trading engine.

Strategy
An instrument composed of two or more legs, including spreads.

Establishing implied prices

An implied order is an order generated synthetically from two outright regular orders that are already registered in the order book. These two orders could be constituted either from two individual legs or one individual leg and a strategy involving that leg. Two types of implied orders exist:

Implied "in": Implied "in" orders are derived from regular posted orders on individual legs. Implied "in" orders allow to create a synthetic strategy market available for trading to all market participants.

Suppose the following regular markets on individual legs:

The implied "in" strategy derived from posted markets would be:

The implied market for the CRA1/CRA2 strategy is a bid at 0.05 for 10 contracts and an offer at 0.15 for 5 contracts. It is important to note that the available tradable quantity in an implied spread generated by the system is the smallest available quantity on each leg in the spread. For example, the offer of 5 contracts in the CRA1/CRA2 spread corresponds to the smallest available quantity on the offer for CRA1 (10 contracts) and on the bid for CRA2 (5 contracts).

Implied "out": Implied "out" orders are derived from a combination of an existing regular spread order and an existing outright order in one of the underlying individual legs. This type of order allows creating a synthetic market on the other underlying leg.

Suppose the following markets on the CRA1/CRA2 spread and on the CRA1 leg (contract):

The implied "out" individual leg derived from these orders would be:

As can be seen, there are three components in an implied order: each of the two individual legs (comprising the calendar spread) and the strategy on the two legs combined. In order to create an implied spread order or an implied "leg" order, two of the three components must be available.

Example of an implied order worked by the trading engine

Posted markets:

Implied strategy derived from posted markets on individual contracts:

A client would like to sell the CRA1/CRA2 implied spread for 100 contracts at 0.07. The client wants to sell CRA1 and to buy CRA2 at a 0.07 price differential. The client enters the order (a regular order) in the order book, which produces the following market:

Note: The buy order of 0.05 on 10 contracts is an implied order (derived from regular orders on individual legs) whereas the sell order of 0.07 on 100 contracts is a regular order. The two posted orders are executable and tradable.

The trading engine will take the client spread order (100 contracts offered at 0.07) and will automatically "work" the order using individual regular orders displayed in the book. Thus, the trading engine through the implied pricing algorithm will produce for the client a tradable offer on the 10 CRA1 contracts at 95.12 in order to buy simultaneously (once the 10 CRA1 contracts are sold at 95.12) the 10 CRA2 contracts displayed (regular order) at 95.05 (for CRA1/CRA2 spread at 0.07). The trading engine will also simultaneously produce a bid of 95.03 for 10 contracts in the CRA2 contract to simultaneously sell (if the 95.03 bid is filled) 10 contracts of the CRA1 at 95.10.

The order book will show the following orders:

Note: The sell order of 10 contracts at 95.12 in CRA1 is an implied order (derived from regular orders in the CRA1/CRA2 spread of 0.07 for 100 contracts and the offer on the CRA2 individual leg). The buy order of 10 contracts at 95.03 in CRA2 is an implied order (derived from regular orders in the CRA1/CRA2 spread of 0.07 for 100 contracts and the bid on the CRA1 individual leg).

As long as the offer for 10 CRA2 contracts at 95.05 is displayed in the order book, the implied sell order for 10 CRA1 contracts at 95.12 will be maintained by the trading engine for the sell execution of the CRA1/CRA2 spread at 0.07. Once a quantity is executed by the trading engine, the total volume of the regular order (CRA1/CRA2 spread market in this case) is adjusted accordingly (i.e. if the trading engine sells 10 CRA1 contracts at 95.12 and simultaneously buys 10 CRA2 contracts at 95.05, the engine will adjust the spread quantity to 90 contracts pending at 0.07 while confirming the partial execution of 10 contracts to the client). The same principle extends to the related regular buy order in CRA1 and implied buy order in CRA2.

Example of an allocation price smaller than the minimum tick

A Strategy trade with any legs having a ratio greater than 1 may have the leg prices for allocation with a minimum tick smaller than each outright leg minimum tick.

Example

A strategy involving 2 CGFH20 (tick = 0.01) and 1 CGBH20 (tick = 0.01) may have a 0.005 (half tick) assigned to the CGF leg for fair leg price algorithm assignment:

Now, assume that someone comes in the outright market offering 120.90 in CGFH20, the 2CGF-1CGB spread will be triggered because of an implied bid price of 120.905 in CGF (see below).

Spread Price = +2 * CGFH20 – 1 * CGBH20

CGB Bid Price = 138.97
Spread Bid Price = 102.84
X = CGF implied bid price
102.84 = 2*X – 1*138.97
X = 120.905

The seller in CGF will get an allocation of 120.905 (wanted to sell 120.90) and the buyer of the spread will get an allocation of 120.905 in CGF (buy) and 138.97 in CGB (sell) resulting from his spread price of 102.84.

Operational process

1. Implied pricing was developed for all protocols supported by MX: SAIL (SOLA Access Information Language), FIX (Financial Information eXchange) and STAMP (Security Trading Access Message Protocol).
2. Implied orders will be disseminated through the HSVF for independent software vendors and data vendors that have developed the functionality.
3. Post-trade dissemination through the HSVF is supported by MX and available to approved participants and data vendors whereby trade data of individual legs resulting from implied orders will be marked distinctively.
4. For end-of-day settlement purposes, only regular orders will be accounted for. However, trades resulting from both regular and implied orders will be considered for required volume computation.
5. For trading purposes, each instrument will retain its current price fluctuation (as determined in the contract specifications).
6. Erroneous trades involving transactions resulting from implied orders will be addressed according to the Procedures for the Cancellation of Trades.