Educational Explanations - The Portfolio Platform

What is a derivative?

A derivative is a financialsecurity with a value that is reliant upon, or derived from, an underlyingasset or group of assets—a benchmark. The derivative itself is a contractbetween two or more parties, and derives its price from fluctuations in theunderlying asset.

The most common underlying assetsfor derivatives are stocks, bonds, commodities, currencies, interest rates, andmarket indexes. 

Our traders mainly use 2 types ofderivatives:

Futures

A Futures contract is an agreementbetween two parties for the purchase and delivery of an asset at an agreed uponprice at a future date. Futures trade on an exchange, and the contracts arestandardized. 

Traders will use a futures contractto hedge their risk or speculate on the price of an underlying asset. Theparties involved in the futures transaction are obligated to fulfil acommitment to buy or sell the underlying asset at the agreed price.

Options

An options contract is similar to afutures contract in that it is an agreement between two parties to buy or sellan asset at a predetermined future date for a specific price. The keydifference between options and futures is that, with an option, the buyer isnot obliged to exercise their agreement to buy or sell. It is an opportunityonly, not an obligation—futures are obligations. 

As with futures, options may be usedto hedge or speculate on the price of the underlying asset.

Annual Return

We display Annualized (Compounded)Rate of Return for most of our strategies. However, for those with less thanone year’s performance we display Cumulative Rate of Return.

It is worth bearing in mind thatstrategies with less than one year, only have limited performance due to thefact that we only show performance achieved via our software. 

For traders to showcase theirstrategy, they must have provided us with previous experience and performance.Becoming a TPP trader is not easy and very few qualify as our standards arevery high.

Strategy subscription costs areincluded in marked-to-market equity calculations

Max Drawdown

This gives a good indication as tothe risk likely to be taking by the trading team. It is the largestpeak-to-valley historical drawdown of the Model Account in dollars. 

Of course, future drawdowns may begreater than this number, but on the whole, we ask our traders to stick totheir risk mandate

Suggested minimum capital

This is an indication of the amountrequired to link up to a particular strategy. If the traders use futures toleverage a position, the suggested minimum may be higher than that of a stocktrader as smaller increments can be used in the ‘scaling’ option.

It isn’t possible to trade a scalingof less that 1 future, so this amount helps guide investors as to what tradersthey can, or cannot, autotrade.

Correlation S&P 500

This lets you know how the S&Phas performed compared to the strategy over the same time frame.

What is Sharpe ratio?

The Sharpe ratio has become the mostwidely used method for calculating the risk-adjusted return. Modern PortfolioTheory states that adding assets to a diversified portfolio that has lowcorrelations can decrease portfolio risk without sacrificing return.

The Sharpe ratio can also helpexplain whether a portfolio's excess returns are due to smart investmentdecisions or a result of too much risk. Although one portfolio or fund canenjoy higher returns than its peers, it is only a good investment if those higherreturns do not come with an excess of additional risk.

The greater a portfolio's Sharperatio, the better its risk-adjusted-performance. A Sharpe Ratio of greater than1 is considered good, a Sharpe Ratio of greater than 2 is exceptional.

What is Sortino Ratio?

The Sortino ratio is avariation of the Sharpe ratio that differentiates harmful volatility fromtotal overall volatility by using the asset's standard deviation ofnegative portfolio returns—downside deviation—instead of the total standarddeviation of portfolio returns.

It essentially takes out whatportfolio managers would consider to be upside (good) volatility and focuses onthe bad. It’s a stronger indicator of risk, but not always of reward.

Beta

Beta is a measure of volatility relativeto a benchmark, and it's actually easier to talk about beta first. It measuresthe systematic risk of a security or a portfolio compared to an indexlike the S&P 500. Many growth stocks would have a beta over 1,probably much higher. A T-bill would have a beta close to zerobecause its prices hardly move relative to the market as a whole.

What beta also tells you is whenrisk cannot be diversified away. If you look at the beta of atypical mutual fund, it's essentially telling you how much market risk you'retaking.

Alpha

Alpha is the excess return on aninvestment after adjusting for market-related volatility and randomfluctuations. Alpha is one of the five major risk management indicators formutual funds, stocks, and bonds. In a sense, it tells investors whether anasset has consistently performed better or worse than its beta predicts.

Alpha is also a measure of risk. Analpha of -15 means the investment was far too risky given the return. An alphaof zero suggests that an asset has earned a return commensurate with the risk.Alpha of greater than zero means an investment outperformed, afteradjusting for volatility.

Margin

Have you ever wished you had alittle more money to invest in the market because it looks a little cheap? Haveyou ever wondered how hedge funds can make better returns than the market?

The answer is margin. A marginaccount rather than a cash account allows you to leverage your position. 

If you have a ‘cash’ account, youcan buy £1,000 worth of stock with £1,000 worth of money. If you have a marginaccount, you can buy £1,000 worth of stock with £100, and the broker will coverthe difference as long as your account equity never dips below your margin.

Leverage

Leverage is the use of marginto increase one's trading position beyond what would be available from theircash balance alone. Leverage, amplifies both profits as well as losses and showshould be left to the professionals.

Benefits of using leverage

Provided you understand howleveraged trading works, it can be an extremely powerful trading tool. Here arejust a few of the benefits:

• Magnified profits. You only have to put down a     fraction of the value of your trade to receive the same profit as in a     conventional trade. As profits are calculated using the full value of your     position, margins can multiply your returns on successful trades – but     also your losses on unsuccessful ones.  
• Gearing opportunities. Using leverage can free up     capital that can be committed to other investments. The ability to     increase the amount available for investment is known as gearing
• Shorting the market. Using leveraged products to     speculate on market movements enables you to benefit from markets that are     falling, as well as those that are rising – this is known as going short.
• 24-hour dealing. Though trading hours vary from     market to market, certain markets – including key indices and forex     markets – are available to trade around the clock.

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