Financial Risk Management Systems for Futures / Options

Introduction
Over the past 18 months, financial and commodity markets have experienced unprecedented volatility. A market can turn against a client’s position in very short order. Now, extrapolate that across multiple markets and multiple clients, and the case for systematic risk management for FCM’s is compelling. The universe of risk management systems capabilities in the futures and options markets is broad, as are the vendors providing these services. Below are some of the aspects of futures and options risk management:

Pre-Trade Risk Management
Pre-trade risk management consists of checking orders before routing them to exchanges, to avoid input errors or excessive risk. A robust trade entry and management system will provide rudimentary pre-trade risk management, such as real-time P&L and positions by account, trader and other parameters. Visual, audible and email alerts are used in these systems, along with advanced filtering and sorting capabilities to focus on specific positions, orders, etc. One example of this type of system is Trading Technologies XTrader.

Post Trade Risk Management[1]
Clearing firms perform end-of-trading day stress-tests on positions, with worst-case scenarios, and correlations across asset classes. While a more accurate picture of a client's risk exposure, these computation-intensive calculations can be too taxing for trading systems.

Risk Analytics
FCMs provide comprehensive pre-trade analytics to facilitate large orders. Analysis of how the market behaves to facilitate timed orders such as volume- weighted average price orders. FCMs are asked to combine the trade execution information with market information to provide a transaction cost analysis. Vendors, who can facilitate this analysis, including access to historical tick-by-tick data, provide an important service offering.

Market Risk Management
Market risk is the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions such as market movements. Generally, market risk management consists of quantifying risk by repricing the portfolio using simulated market prices and rates. The most common of these is Value at Risk (VaR), which reduces measure to a single number (a threshold value such that the probability that the mark-to-market loss on the portfolio over the given time horizon exceeds this value (assuming normal markets and no trading in the portfolio) is the given probability level.) Monte Carlo analysis using scenario generation can also be used. Shocks are provided by price, volatility, and contract expiration.



Portfolio Risk Management



Interactive Brokers Risk Navigator

Enterprise Risk Management
An enterprise risk management (ERM) system for an FCM should be able to measure P&L and risk at end of day and intra-day for all asset classes and across books, desks and trading locations. A robust system will provide both portfolio-level view and individual positions.
Tools to manage trading limits, notify management when limits are approached or exceeded, and amend and correct end-of-day data are important. In addition to the real-time and end-of-day perspective, the accumulation of historical data will allow the firm to view and analyze historic P&L and risk returns.

[1] Rosenthal Collins Group (RCP) recently developed a proprietary risk management system (RiskHunter) that uses Complex Event Processing (CEP) to seek out anomalous trading patterns among its customers, and so provide Risk Management controls between pre- and post-trade. RCG has filed for patent protection on this technology.