Virtual Hedged Derivative Instruments for Automated Exchange Matching
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Solution Overview
Problem
Automated exchange systems face challenges in efficiently processing hedged derivative orders, leading to high execution risk and processing power bottlenecks due to the complexity of delta hedging and the need for simultaneous trading of multiple contracts.
Innovation Solution
The system introduces virtual hedged derivative instruments, allowing traders to execute trades in a separate, delta-neutral environment, where the matching process occurs only for the virtual instrument, with the corresponding underlying trades calculated later, reducing processing demands and execution risk.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Reliability
If delta hedging is performed by simultaneously trading multiple contracts in two or more places, then the market maker can offset the open position and reduce risk, but the processing power requirements increase and execution risk increases due to price changes between trades
Solution Approach 1:
The patent segments the hedging process into two independent stages: first, the virtual instrument is traded to establish the hedge ratio; second, the underlying contracts are traded to execute the actual hedge. This segmentation allows the matching unit to process only simple virtual instrument trades rather than complex multi-contract combinations, significantly reducing processing power requirements while maintaining reliable execution.
Solution Approach 2:
The patent introduces a virtual instrument as an intermediary that represents the hedged derivative position. By trading the virtual instrument first to determine the hedge ratio, and then using this ratio to execute underlying contract trades, the system eliminates the need for complex real-time matching of multiple contracts, reducing both processing complexity and execution risk.
2Productivity
If combination orders are used to trade multiple contracts simultaneously, then the trading can be done in one place, but the processing power of the matching unit is consumed and creates bottlenecks
Solution Approach 1:
The patent extracts the complex matching logic from the matching unit by introducing virtual instruments. The matching unit only needs to match simple virtual instrument orders, while the complex calculation of underlying contract trades is performed separately in the deal capture module, freeing the matching unit from processing power constraints.
Solution Approach 2:
The patent performs preliminary action by first trading the virtual instrument to establish the hedge ratio before executing the actual underlying contract trades. This preliminary step simplifies the subsequent matching process and allows the system to handle complex hedging strategies without consuming excessive processing power.
3Productivity
If the market maker trades derivative contracts without hedging, then the trading can be executed quickly with minimal processing, but the market maker assumes execution risk and liquidity risk from price changes
Solution Approach 1:
The patent creates a virtual instrument that copies the characteristics of the derivative contract but in a simplified form that can be traded without immediate execution risk. The virtual instrument trade establishes the hedge ratio, and the actual underlying contract trades are executed separately, allowing the market maker to maintain trading speed while eliminating execution risk.
Data Source
AI summary
In an automated exchange system, a separate virtual instrument is used in the matching process of the system. The virtual instrument guarantees that both a derivative instrument and its underlying instrument are traded together. The underlying instrument, i.e. the instrument in which derivative instruments are traded, is then preferably displayed together with the virtual instruments. The underlying instrument is presented with a price. The matching of the virtual instrument can take place in a matching module of the automated exchange system. After a trade in a virtual instrument is matched in the matching process of the system, the match is reported to a subsequent deal capture module where the corresponding different trades or deals of the virtual instrument are formed. The trades or deals formed in the deal capture module do not need to be matched because the number of instruments and the price can be deduced from the information relating to the virtual instrument.