Here’s a mock trading game I learned as a trainee to simulate futures and options market making. This game was commonly used as a day 1 exercise in trading class or when interviewing cohorts of college grads during recruiting “combines”.
The Futures Game
What you need:
- A deck of cards
- Nerdy friends (the more the better)
- A paper and pen per person to use as a tradelog
You want to deal out enough cards to players (these are the market makers) so that there is about 25 remaining in the deck. There’s some leeway here.
- You have 6 players. So deal them each 4 cards leaving 28 cards undealt.
- Market makers may look at their hands but don’t share info.
- The undealt cards are known as the “public pile”. They should be evenly divided into 4 or 5 sub-piles ideally (again there’s leeway depending on how many cards there are).
- The sub-piles are going to represent “trading days”.
- The cards themselves are news flow which will move the futures prices.
Description of futures prices:
- The futures are the 4 suits. There’s a club’s market, a spades market, etc.
- The final settlement price of the futures will be the sum of the ranks of cards in the public pile. (Ace =1 thru King = 13). So the maximum any future can be worth is 911
It’s best to define the tradeable universe to keep the liquidity centralized.
So you could have a diamond market, a spades market, and a “reds” market (which would be an index settling to the sum of diamonds and hearts).
How To Play
The first trading day
- Reveal the cards in the first public sub-pile.
- Market makers make bids and offers for the various markets. Tight 2 sided markets should be encouraged/required. For example:John: “I’m 65 bid for Hearts and offered at 68”
Jen: “I’ll pay 67 for 5 Hearts contracts” (perhaps Jen is holding no Hearts in her hand)
John: “Sold you 5 at 67” (John is holding 16 points of Hearts in his hand)
- Record all your trades on your own pad or paper:1. Which contract you bought/sold
2. Quantity of contracts
3. Price of contracts
So for example, if I paid 51 for 4 “clubs contracts” from Mary I would record that information on my paper. Mary would record her sale of the 4 contracts at 51 on her card with me as the counterparty.
- The trading is open outcry. There are no turns.
Settling the trading day
- When the trading peters out for that “day” everyone should check their trades against their counterparties to make sure there are no so-called breaks or “outtrades”.
- On a central eraseboard or paper the “closing price” of each market can be recorded. So if the King of clubs and 3 of clubs were revealed from the sub-pile, then clubs “settled at 15”. Clubs might have traded 53 last in the expectation that more clubs will be revealed on subsequent days.
- Repeat this process for all remaining tradings days
The last settlement
- Compute “P/L” for all trades.
If I bought 4 clubs contracts for $51 and clubs final settlement was $63 then I made a profit of $12 x 4 or $48. Mary’s loss would match that amount for that trade.
The total P/L of all traders should sum to zero at the end of the game.
- Either the same group or a different group of people could choose to trade calls and puts on the final settlement price of the futures.
So if I paid 3 for Clubs 55 calls and the final settlement was $63 then I profit the difference between the $63 and the strike ($55) minus the premium I outlayed:
$63-$55 – $3 = $5
- You could even get fancy and trade “vol”. You could sell say 10 clubs calls and buy 5 clubs futures to hedge the delta.
- This game is played the same way the futures game is played or in conjunction. Repeat the process for all trading days then compute P/Ls at the end. Again if there are no errors the game should be zero-sum.
- Here’s the trick to summing the numbers 1 through N or in this case 1 thru 11.
So 11×12/2 = 66
Let’s try another. Sum the numbers 1 through 100.
100×101/2 = 5050
Why does this work?
Pair the ends off.
100 + 0
99 + 1
98 + 2
97 + 3
…continue until 51+49
What do you end up with:
- 50 pairs summing to 100
- The middle “50” left over.50×100+50 = 5050.
That maps to (N/2) x N+1 or “the middle number occurs N + 1 times”. That 1 term is the “middle 50”.