Labuszewski et al. The CME Group Risk Management Handbook

The CME Group Risk Management Handbook: Products and Applications by John W. Labuszewski, John E. Nyhoff, Richard Co and Paul E. Peterson (Wiley, 2010) is, as its title suggests, a reference book with a marketing edge. After chapters on futures markets fundamentals, order entry and execution methodologies, and the role of the clearinghouse, we move on to the main body of the book. Here the authors describe the principal CME Group futures products and show how they can be used as integral parts of risk management strategies. A brief account of fundamental market indicators and a longer technical analysis primer follow. Finally, we are introduced to options on futures and various option strategies traders can use to hedge their positions. The book, 606 pages in length, is far more than a rehash of material available on the CME Group site.

For instance, take something as seemingly straightforward as hedging a diversified stock portfolio with stock index futures. How do you calculate the hedge ratio? You divide the monetary value of the stock portfolio by the fair value of, say, one E-mini S&P 500 futures contract and multiply that by the weighted beta of the portfolio. The answer will be the number of futures contracts you need to sell to hedge the portfolio.

Or assume a less radical hedge where an investor, in anticipation of a near-term market advance, wants to keep his portfolio’s size constant but increase its beta from 1.05 to 1.20. In that case, the formula would be (value of the stock portfolio / value of the index) x (1.20 – 1.05).

The hedge ratio for currencies is even simpler: the value of risk exposure / futures contract size. For example, a U.S. company whose financial statements are denominated in U.S. dollars agrees to sell goods for future delivery and a future payment of €50,000,000. Exposed to the risk of a declining euro versus the U.S. dollar, the company might decide to hedge its risk exposure by selling EuroFX futures worth €125,000 per contract. It would, using this simple formula, have to sell 400 EuroFX futures contracts.

An outright hedge is only one strategy outlined in this book, though it receives the most attention. We are introduced, for example, to calendar spreads in gold futures, to trading the curve with treasury futures, and to intermarket currency spreads.

Anyone who has experience trading futures should expect to find some of the material in this book very familiar, other material somewhat familiar, and the remainder refreshingly new. I, for instance, learned a great deal from the chapters on Eurodollar futures and Treasury futures because I have had limited exposure to them, much less so from the chapter on stock index futures, and virtually nothing from the sections on technical analysis and options. Since every trader is on a different learning curve and few traders are eclectic in their choice of instruments, I’m certain that there’s valuable material for everyone in this handbook. Whether you’re interested in repo financing or soybeans, esoteric weather products or the TED spread, you’ll find a clear, thorough discussion.