Hedging Overview
MFX Compass has 2 main hedging algorithms, the Hybrid Hedger, and the Arbitrage Hedger (usually just 'Arb Hedger').
As we receive trades from clients, which naturally exposes us to risk, our VaR increases. VaR in Compass is calculated using equivalent positions:
Client trades are split down and bucketed by their individual assets to form positions in each currency, known as equivalent positions. For example, a client's 1M BUY USDJPY will be split into a $1M long USD position, and a $1M short JPY position, for the house. Each trade will undergo this process, and the assets will be collected together. Using the covariance matrix, the optimal hedges will be calculated - the result will be equivalent positions for each currency. Each of these equivalent positions contributes to the overall VaR of the system.
The hedgers are then triggered to trade for risk management based on VaR. They will make risk reducing hedges by trading in instruments that reduce equivalent positions, and hence VaR. So, for example, while our risk may have increased due to a large client trade in USDJPY, the hedgers will not necessarily hedge in USDJPY, but will look at equivalent positions in the books, and hedge in instruments that reduce these.
This means that unlike brokering, we do not hedge trades individually, but rather the book's equivalent positions are hedged against. The book each hedger operates on the positions of is defined in the config key risk.riskParty.
Hybrid Hedger
The hybrid hedger exists as hedging profiles. These are configurations which contain hedging rules, which decide when and how to hedge. The hedging rules consist of four separate configurable processes:
- Triggers - These are the conditions that, once met, signal to the hybrid hedger to begin trading - only one trigger must be met.
- Guards - These are simple conditions, unrelated to the proposed hedge (timezone blacklist/whitelist, etc.) that must all be met for the hedging rule to be activated.
- Predicates - These are checks made on the proposed hedge, which must all be met for the trade to be executed.
- Strategy Parameters - These parameters govern how the hedger will trade, once a trigger is met.
We can alter how the hybrid hedger trades based on parameters such as the max spread it should pay, and how long it should look to hedge before another rule kicks in.
Arb Hedger
The arb hedger, which can be run as either risk increasing or risk reducing (see below), looks for inefficiencies in LP pricing as a way to either cheaply exit risk, or make profit.
It does this by essentially acting as an automated trader, searching the market for arbitrage opportunities and taking advantage to exit risk (risk reducing) or make proprietary trades for profit (risk increasing).
Like the hybrid hedger, the arb hedger is triggered by VaR, but unlike the hybrid hedger, it is not bound by time, so it can continue searching for arbitrage opportunities to exit risk until a suitable trade, as configured by spread appetite etc., presents on the market.
The hybrid and arb hedgers cannot both act at the same time; whichever hedger's triggers are met first will fire first and begin trading.