9rorrlt
uildingBelterPerform.rnGeCOMMENTARY
72
SEPTEMBER
2OO2
HOW
BIG
IS
THE
STRIKE
ZONE?
At the heart
of
PlexusGroup'stransactioncostmeasurement is thecomparisonof the"strikeprice"
at
the
time
whenthe tradeorder
became
actionable to the transactionpricesreceived
in
the
marketplace.The difference is
the
cost
of
implementing the
order.
In
this
spotlight, we discuss how Plexus establishes
a strikeprice,andpresentsome ideas on
how
to setmorerepresentative strike
prices.
Strike
Prices
The
financial
managementindustry
assigns
greatprominence
to markei
prrces.
Yet
we all
realize
thatany
historicalpriceisno more
than
a
snapshot
or
a
flicker of
a
volatile, dynamicprocess.
Suppose
a
portfoliomanager forwardsan order
to
his trade desk
on
February 13th
at
forty
seconds
after
1:30
in
the
afternoon.
The
implementation
shortfall
methodology
requirescomparing
price
movementsbetween this
point
of initiation(the
strike
price)and
the
ultimate
execution
prices.Shouldweaccept
the
bid,
the ask,
or
the
lastprint(13:30:40
on
2113102)
as
the
best benchmark?
Did
the
portfoliomanager
really
focus
all
of
his intellectualpower
on
that
particular
instant?
ln
contrast,
would
some
appropriate
sample
of
the
concurrent
stream
of
pricesresult
in
a
more representativestrikeprice?
Years ago Plexusadopted a solution for this
strike
price question
that
applied
a
"representativetimeframe"
approach.
We
knew
-
or
could
infer
-
the
time
at
which theorder waspresented
to
the
buyside
trade desk,
but
we
were
concerned
about
therepresentativeness
of
these
flickerprices.
Our
solution
was
to
averageprices
surrounding
themoment
of
order release.Somewhat arbitrarily,
we
chose a
ten
minute
clock
periodduring
which
the
order
was
received
on the
trade
desk.
Our
loqic
was
as
follows:
1
.
Byusing an average
we
minimize the effects of the
bouncing ofpricesbetween bid and asked.2.
We
selected the volume
weighted
priceforthis
short timeintervalinstead
of
the
mid-spread
price
because
it
would
tend
to
weigh
the
preponderance
of
buyers
and
sellers
in
the
market:
When
buyerswere dominant, the volume
weightedprice
would
likely
be
above
the
mid-
spread
price.
3.
Averaging
dampens
the
pafticularly
unstableopening andclosing
prices.
4.
The
recording
of
time
stamps
into
the
order
management
systems
is
often
subject
to
smallrandom
delays.
5.
Most investment managers
base
theirselections
on
a
thresholdprice,
not
on a specific momentary
orice.
6.
Organizing our databases on a
ten
minute time
slice
vastlyaccelerates dataretrieval and reducesstoragerequirements.
While
ten
minutes
felt
"aboutright,"noteverybodybuys
into
this
logic.
Some argue
that
ten minutes
is
too
long
an
intervalwhen
markets aremoving
rapidly.
So we decided
to
re-examine our assumptions
in
the
light
of new data capabilities
at
Plexus.
We looked
into
our
new
daily-updateddatabasesof
tick data on the
8000+
most widely tradedstocks
on
theplanet.
Weexaminedthe dis-tribution ofnumber
of
tradesper
day
across
all
companies.
We
then
expanded
our
investigation
to
focus
on
non-retail
tradesgreater
than
1000shares
or
5000
shares
per
trade.
The tableshowsthecompiledinformation for the
last
trading
day
in
June,
2001.
Any
of
the
first
three
columns
can
be read as a
category.
To
illustrate,consider
the
last line
in the
table.
One
company
(Cisco)
recorded52,455 tradesthat
day,
874+
perminute,
or
on
average
one
every seven-hundredths
of aminute.
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