System And Method For Creating And Trading A Digital Derivative Investment Instrument

• US 20080313095A1
• Filed: 06/28/2007
• Published: 12/18/2008
• Est. Priority Date: 05/04/2005
• Status: Abandoned Application

• Current Assignee: Chicago Board Options Exchange Incorporated (Cboe Global Markets, Inc.)
• Original Assignee: Chicago Board Options Exchange Incorporated (Cboe Global Markets, Inc.)
• Inventors: Shalen, Catherine T.
• Application Number:
  US11/770,693
• Publication Number:
  US 20080313095A1
• Time in Patent Office: Days
• US Class Current: 705/36R
• CPC Class Codes: G06Q 40/00 Finance; Insurance; Tax strategies; Processing of corporate or income taxes
• CPC Class Codes: G06Q 40/04 Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange
• CPC Class Codes: G06Q 40/06 Asset management; Financial planning or analysis

Abstract

A method and system for auctioning an investment instrument that allows investors to take risk positions relative to the occurrence or non-occurrence of a contingent binary event is disclosed. The contingent binary event will have one of two possible outcomes. Tn a digital derivative contract, a long investor agrees to pay a short investor a contract amount in return for the short investor agreeing to pay the long investor one of two different settlement amounts depending on the outcome as the contingent binary event. Typically, one settlement amount will be zero and the other will be an amount greater than the digital derivative contract price. All of the digital derivative contracts that settle in-the-money may be funded by those that settle out-of-the-money.

Claims

1. A method for conducting an auction, comprising:

establishing parameters for at least one defined state corresponding to at least one potential outcome for a selected financial instrument;

collecting and storing orders in an electronic database prior to an occurrence of the at least one potential state, the orders comprising at least one defined state, a size and a payout value associated with the selected financial instrument;

initiating a timer;

adjusting the payout value of the selected financial instrument corresponding to the size of orders entered by at least one market participant for the selected financial instrument before an expiration of the timer;

identifying the occurrence of the at least one defined state before the expiration of the timer;

determining an allocation percentage of the orders for allocating the selected financial instrument stored in the electronic database among market participants; and

allocating the orders having the adjusted payout value in the electronic database, wherein the adjusted payout value is zero for orders having the at least one defined state that did not occur before the expiration of the timer and wherein the sum of all adjusted payout values for orders having at least one defined state that did occur is less than or equal to a total payout value for all orders.

2. The method according to claim 1, wherein determining the allocation percentage comprises calculating a participation component and a pro rata component for each market participant.

3. The method according to claim 1, wherein allocating the orders comprises multiplying the determined allocation percentage for each respective market participant by an adjusted value component comprising a change in value between the payout value and the adjusted payout value of the entered orders.

4. The method according to claim 1, wherein the at least one defined state is constructed from a distribution of potential outcomes that are mutually exclusive.

5. An exchange configured for auctioning of a selected financial instrument by a combination of electronic and open-outcry trading mechanisms, comprising:

an interface for receiving an incoming order to purchase the selected financial instrument, the incoming order having a size and a payout value associated therewith;

a book memory for storing a plurality of previously received orders, the previously received orders each having a size and a payout value associated therewith;

a system memory for storing predefined condition parameters for at least one defined state corresponding to at least one potential outcome for the selected financial instrument and allocating parameters for allocating orders among market participants;

a timer adapted to time the auction, including a beginning and an expiration;

a processor configured to allocate orders among the plurality of previously received orders in the book memory based on the condition and allocating parameters in the system memory, wherein the condition parameters include at least one parameter for identifying an occurrence of at least one defined state occurring before the expiration; and

wherein the processor is further configured for calculating a zero payout value for orders having the at least one defined state that did not occur before the expiration of the timer and a greater than zero payout value for orders having at least one defined state that did occur, wherein the sum of all payout values for orders having at least one defined state that did occur is less than or equal to a total payout value for all orders.

6. The exchange of claim 5, wherein the allocating parameters comprise parameters for allocating preferentially against orders with larger size.

7. The exchange of claim 5, wherein the allocating parameters comprise a participation component and a pro rata component for each market participant.

8. The exchange of claim 5, wherein the processor is configured to allocate the orders among the previously received orders by multiplying a determined allocation percentage for each respective market participant by an adjusted value component comprising a change in value between the payout value and the adjusted payout value of the orders.

9. The exchange of claim 8, wherein the at least one defined state is constructed from a distribution of potential outcomes that are mutually exclusive.

10. The exchange of claim 5, wherein the condition parameters comprise at least one parameter for identifying an occurrence of at least one defined state before the expiration and wherein the allocating parameters comprise parameters for allocating preferentially against orders with time priority.

11. The exchange of claim 5, wherein the allocating parameters include parameters for calculating an allocation percentage based on a formula that allocates the order identified with a market participant;

and

wherein the allocation percentage of the order identified with the market participant is;

X%=siz[mp]/(siz[mp]+siz[pro])

where siz[mp] is the size of the order identified with the market participant, and size[pro] is the sum of the sizes of professional orders not identified with the market participant.

12. An auction system for the purchase or sale of a selected financial instrument in an exchange configured for auctioning of financial instruments by a combination of electronic and open-outcry trading mechanisms, comprising:

an electronic trade engine for receiving an incoming order to trade the selected financial instrument, the incoming order having a size and a payout value associated therewith;

a database in communication with the electronic trade engine for storing a plurality of previously received orders, the previously received orders each having a size and a payout value associated therewith, the database also for storing predefined condition parameters for at least one defined state corresponding to at least one potential outcome for the selected financial instrument and allocating parameters for allocating a payout to each order;

a trade processor in communication with the database for analyzing and executing orders according to an allocation algorithm for allocating a payout to each order among the plurality of previously received orders in the database based on the condition and allocating parameters therein, wherein the condition parameters include at least one parameter for identifying an occurrence of at least one defined state before an expiration of a timer; and

wherein the allocating parameters include parameters for calculating a zero payout value for orders having the at least one defined state that did not occur before the expiration of the timer and a greater than zero payout value for orders having at least one defined state that did occur, wherein the sum of all payout values for orders having at least one defined state that did occur is less than or equal to a total payout value for all orders, the allocating parameters allocating preferentially against orders with larger size.

13. A computer-readable medium comprising processor executable program instructions for carrying out the following steps:

establishing parameters for at least one defined state corresponding to at least one potential outcome for a selected financial instrument;

collecting and storing orders in an electronic database prior to an occurrence of the at least one potential state, the orders comprising at least one defined state, a size and a payout value associated with the selected financial instrument;

initiating a timer;

adjusting the payout value of the selected financial instrument corresponding to the size of orders entered by at least one market participant for the selected financial instrument before an expiration of the timer;

identifying the occurrence of the at least one defined state before the expiration of the timer;

determining an allocation percentage of the orders for allocating the selected financial instrument stored in the electronic database among market participants; and

allocating the orders having the adjusted payout value in the electronic database, wherein the adjusted payout value is zero for orders having the at least one defined state that did not occur before the expiration of the timer and wherein the sum of all adjusted payout values for orders having at least one defined state that did occur is less than or equal to a total payout value for all orders.

14. The computer-readable medium of claim 13, wherein determining the allocation percentage comprises calculating a participation component and a pro rata component for each market participant.

15. The computer-readable medium of claim 13, wherein allocating the orders comprises multiplying the determined allocation percentage for each respective market participant by an adjusted value component comprising a change in value between the payout value and the adjusted payout value of the entered orders.

16. The computer-readable medium of claim 13, wherein the at least one defined state is constructed from a distribution of potential outcomes that are mutually exclusive.

17. The computer-readable medium of claim 13, wherein determining an allocation percentage comprises calculating an allocation percentage based on a formula that allocates the order identified with a market participant, wherein the allocation percentage of the order identified with the market participant is:

X%=siz[mp]/(siz[mp]+siz[pro])

where siz[mp] is the size of the order identified with the market participant, and size[pro] is the sum of the sizes of professional orders not identified with the market participant.

18. A method of creating a financial instrument comprising:

identifying a credit default rating service having a credit default rating scheme comprising a plurality of default categories;

mapping the default categories to monetary values;

identifying an entity which is rated by the credit default rating service; and

creating a credit default derivative investment instrument whose value is determined at least in part by the monetary value to which the default category associated with the rated entity is mapped.

19. The method according to claim 18, wherein the plurality of default categories includes bankruptcy.

20. The method according to claim 18, wherein the plurality of default categories includes non-payment of a debt.

21. The method according to claim 18, wherein the entity is a corporation.

22. The method according to claim 18, wherein the entity is a sovereign entity.

23. A credit default derivative investment instrument comprising:

a value determined at least in part by a monetary value to which a default category associated with a rated entity is mapped;

wherein the default category is one obtained from a credit default rating service having a credit default rating scheme that includes the default category, and wherein the default category has been associated with an entity by the credit default rating service.

24. A method of creating a financial instrument comprising:

identifying a credit default rating service having a credit default rating scheme comprising a plurality of default categories;

identifying a default status of an entity, wherein the default status corresponds to an appropriate one of the plurality of default categories assigned by the credit default rating service to the entity;

establishing a digital derivative contract in which an investor will receive one of a first settlement amount or a second settlement amount depending on whether a strike price of the digital derivative contract is less than, equal to, or greater than a value of the default status; and

settling the digital derivative contract according to whether the strike price of the digital derivative contract is less than, equal to, or greater than the value of the default status at expiration of the digital derivative contract.

25. The method according to claim 24 wherein the plurality of default categories includes bankruptcy.

26. The method according to claim 24 wherein the plurality of default categories includes non-payment of a debt.

27. The method according to claim 24, wherein the entity is a corporation.

28. The method according to claim 24, wherein the entity is a sovereign entity.

29. The method according to claim 24 wherein the digital derivative contract is based on and settles against an average of credit default swap spread mid-quotes of market participants at a close of a last day of trading and wherein the digital derivative contract specifies (a) a reference entity of an underlying credit default swap, (b) a specific debt security that serves as a reference obligation, (c) a potential credit event, and (d) a maturity of the credit default swap at the expiration of the digital derivative contract.

30. A computer-readable memory comprising processor executable program instructions for executing the steps of:

identifying a reference entity subject to a potential credit event that includes a plurality of default categories, wherein the entity'"'"'s default status is assigned by associating an appropriate one of said plurality of default categories with the entity;

establishing a digital derivative contract in which an investor will receive one of a first settlement amount and a second settlement amount depending on whether a strike price of the digital derivative contract is less than, equal to, or greater than a value of the default status; and

settling the digital derivative contract according to whether the strike price of the digital derivative contract is less than, equal to, or greater than the value of the default status at expiration of the digital derivative contract.

31. An exchange configured for trading a credit default derivative investment instrument by a combination of electronic and open-outcry trading mechanisms, comprising:

an interface for receiving an incoming order to purchase the credit default derivative instrument, the incoming order having a size and a payout value associated therewith;

a book memory for storing a plurality of previously received orders, the previously received orders each having a size and a payout value associated therewith;

a system memory for storing predefined condition parameters for at least one defined state corresponding to at least one potential outcome for the credit default derivative instrument; and

a processor adapted to allocate orders among the plurality of previously received orders in the book memory based on the condition parameters, wherein the condition parameters include at least one parameter for identifying an occurrence of at least one defined state occurring before the expiration; and

the processor further adapted to calculate a zero payout value for orders having the at least one defined state that did not occur before an expiration of the credit default derivative instrument and a greater than zero payout value for orders having at least one defined state that did occur prior to the expiration of the credit default derivative instrument.

32. The exchange of claim 31, wherein the system memory further comprises allocating parameters for allocating orders among market participants.

33. The exchange of claim 32, wherein the processor is further configured to allocate the previously received orders based on the allocating parameters in the system memory and wherein the allocating parameters include parameters for allocating preferentially against orders with larger size.

34. The exchange of claim 33, wherein the credit default derivative investment instrument comprises a digital option contract.

35. The exchange of claim 33, wherein the credit default derivative investment instrument comprises a digital futures contract.

36. The exchange of claim 33, further comprising a clearing system in communication with the processor, the clearing system adapted to settle the credit default derivative instrument.