Hi, How to arrive at $1.2mil for palladium and $12mil for US 10 year treasury? Thanks.
Course Name: [Futures Trading: Concepts
Hello,
We want to allocate more capital to low volatile asset and less capital to highly volatile asset in order to allocate equal risk to both of them (volatility parity approach).
- The annualised volatility of palladium is 31.05% which is way higher than the 3.32% annualised volatility of 10-year US Treasury. Since we want to give an equal chance for these two contracts to contribute to the PnL of the portfolio, we can’t use the same capital for both contracts. Instead, we will consider the volatility and allocate more capital to less volatile contract and less capital to more volatile contract (volatility parity approach).
- The contract size of palladium is 100 and the treasury contract size is 1000
- Consider the portfolio size of $5 million
- Consider 0.5% as a risk factor, i.e. the daily pnl target we are expecting on the portfolio to move daily on an average. 0.5% of $5 mil is $25,000.
- The daily variation of the palladium contract is $4669.70 and 10-year US Treasury is $288.61. Dividing the risk factor $25000 with daily variation will give us the number of contracts. i.e. 5 contracts for palladium and 86 contracts for 10-year US Treasury
- Notional value = no. contracts X last traded price of contract X contract size
palladium notional value = 5 X $ 2453.8 X 100 = $1,226,900.0 (~ $1.2 million)
10-year US Treasury notional value = 86 X $ 138.08 X 1000 = $11,874,718.75 (~ $12 million)
You can refer to this notebook for these calculations. Please let us know if you have any more queries on this.