Finding Alphas, 2nd Edition

30Finding Alphas on Futures and Forwards

By Rohit Agarwal Rebecca Lehman, and and Richard Williams

Finding alphas in the futures and currency forwards markets is an area of great practical interest. It also presents many challenges, some analogous to those in other markets, such as equities and exchange-traded funds, and some unique to these specific instruments. This chapter will discuss some of the techniques and ideas that have been useful in attacking these challenges over the past few years.

KEY MARKET FEATURES

Futures are designed to give the trader exposure to price changes in an underlying asset without the cost of holding the equivalent position in that asset. Tradable futures markets include futures on equity indices, commodities, currencies, and bonds. In the context of alpha research, short-dated forwards on currencies provide a similar form of access to relative currency value exposures. This makes futures and forwards particularly convenient instruments for both hedgers and speculators, and gives rise to their most significant features.

UNDERLYING FACTOR EXPOSURE

Because both futures and forwards give exposure equivalent to that of an underlying asset, it follows that the prices of the futures and forwards depend on the same factors that drive that asset. This simple observation has important implications. There are distinct groups of market traders who focus exclusively on particular sets of futures and currencies; the hedgers seek to control their exposure ...