Dominion's Hedging System Combines IAC, Algorithmics

Dominion Securities Inc., the securities arm of Royal Bank of Canada, is testing a hedging system for its equities and derivative products operation that brings together Integrated Analytics Corp.'s MarketMind and Algorithmics Inc.'s HedgeWatch products. Indeed, the two vendors have worked so closely on the implementation that they've decided to create a joint venture to further develop the system and market it worldwide.

MarketMind is a decision support system that uses so-called fuzzy logic to apply user-defined analytic algorithms to real-time data (TST, Feb. 26). Fuzzy logic allows the user to measure the degree to which a stated relationship between selected parameters is true. MarketMind permits the trader to monitor price movements in as many as 2,000 securities simultaneously.

HedgeWatch, meanwhile, allows the user to create a synthetic portfolio of securities that behaves like an option needed for risk management purposes. Available exchange- listed instruments may not offer a suitable contract size, maturity or strike price. The institution may want to opt instead for a synthetic option product made up of a set of exchange-listed products that replicates the behavioral elements of the desired option.

For example, to replicate a three-year put option with a $23 strike price, HedgeWatch might recommend a synthetic portfolio comprising amounts of cash, the underlying instrument, a four-month $23 call option, a four-month $23 put option and a four-month $26 call. The trader would define the range of market values of these instruments at which the synthetic portfolio would be effective.

According to Ron Dembo, president of Algorithmics, HedgeWatch can be used either to monitor the effects of holding securities a user doesn't have or to discover the consequences of hedging a set of stocks he already holds.

Dominion's traders are using the combined IAC/Algorithmics product, which hasn't yet been named, to hedge the Toronto Stock Exchange stock index for clients. According to Doug Steiner, vice president and director at Dominion, 10 traders have access to the combined IAC/Algorithmics system.

Traders access the system via Sun Microsystems Inc. SPARCstation-1 workstations running UNIX. Traders receive both Canadian and U.S. market data from Telerate Inc.'s AutoQuote product. Steiner says Dominion is currently testing Reuters Holdings PLC's RQF digital feed.

Data are delivered to a Sybase Inc. database residing on an IBM 490 RISC server, which distributes the feeds to the SPARCstations via an Ethernet local area network. According to Steiner, the new hedging system sits on the workstation with a proprietary order-execution and decision-support system built for Dominion by IAC.

"At the moment, we're taking the two products and integrating them in a fairly straightforward way," says Algorithmics' Dembo. "As they are, the products really complement each other. MarketMind is able to track securities, apply simple rules to securities; and HedgeWatch is able to create synthetic securities in real time." Using MarketMind's RulePage, which contains user-defined parameters for monitoring securities, the trader is able to identify the range of market values over which HedgeWatch would replicate his ideal hedge instrument.

Steiner says HedgeWatch "will use Integrated Analytics' proprietary technology to watch all instruments trading in the market and select the best instruments for the hedge."

According to Dembo, HedgeWatch would make suggestions to traders within the MarketMind context. "Say we were monitoring a particular index option," he says, "and we wanted to look at some further options on the same index. We might be calculating a synthetic portfolio each second and what that does for a market maker in options would be to suggest a pricing mechanism."

Dembo adds: "You could think of it, although this is somewhat simplistic, as a more sophisticated rule being applied to MarketMind. ... It almost looks like an option to MarketMind."

IAC and Algorithmics plan to market the system now in beta test at Dominion and develop a new product that would introduce Algorithmics' RiskWatch system to the equation. RiskWatch is a risk-measurement system for the energy, foreign exchange and commodities markets. It allows the user to measure the sensitivity of a position to changes in interest and foreign exchange rates.

The companies are in the process of creating a joint venture to pursue these aims. Dale Prouty, president of IAC, declines to discuss the business details of the venture. But it's known that the joint company, to be incorporated in Toronto, will be called Soho Financial Engineering Inc. According to Dembo, Soho will market its products worldwide, beginning in New York. Dominion's Steiner says, however, that the firm has "an exclusive agreement with both Integrated Analytics and Algorithmics in Canada."

Dembo says the next joint product will be more innovative than the existing product. "It will be a much more integrated version of what we have now," he says, "so that you'll be able to communicate between the risk evaluation modules [of RiskWatch] and the actual hedging modules [of HedgeWatch], and MarketMind."

From the MarketMind page, the user also could create an aggregate graphical representation of his current exposure. "Once you've calculated your risk exposure and you're viewing it," says Dembo, "you might say "hedge the Deutsche mark position for me" and [the system] goes to the database for the short-term Deutsche mark options and makes an automatic hedge."

Dembo says Soho will begin beta testing the new product toward the end of the year. "We will be able to test it in a real setting where we'll actually be tracking an index, a market index option."

Hedgewatch runs on Sun, DEC, IBM and Hewlett-Packard Co. hardware. The software was written in C, runs on UNIX and is X Windows compatible. For Soho, Dembo says, IAC is porting MarketMind to DEC hardware running Ultrix, DEC's UNIX operating system.