Documentation

Specifying Constraints with ConSet

Introduction

Both hedgeopt and hedgeslf accept an optional input argument, ConSet, that allows you to specify a set of linear inequality constraints for instruments in your portfolio. The examples in this section are brief. For additional information regarding portfolio constraint specifications, refer to Analyzing Portfolios.

Setting Constraints

For the first example of setting constraints, return to the fully hedged portfolio example that used hedgeopt to determine the minimum cost of obtaining simultaneous delta, gamma, and vega neutrality (target sensitivities all 0). Recall that when hedgeopt computes the cost of rebalancing a portfolio, the input target sensitivities you specify are treated as equality constraints during the optimization process. The situation is reproduced next for convenience.

TargetSens = [0 0 0];
[Sens, Cost, Quantity] = hedgeopt(Sensitivities, Price,... 
Holdings, FixedInd, [], [], TargetSens);

The outputs provide a fully hedged portfolio

Sens =
         -0.00          -0.00          -0.00

at an expense of over $23,000.

Cost =
      23055.90

The positions required to achieve this fully hedged portfolio are

Quantity' =

        100.00
       -182.36
        -19.55
         80.00
          8.00
        -32.97
         40.00
         10.00

Suppose now that you want to place some upper and lower bounds on the individual instruments in your portfolio. You can specify these constraints, along with a variety of general linear inequality constraints, with Financial Toolbox™ function portcons.

As an example, assume that, in addition to holding instruments 1, 4, 5, 7, and 8 fixed as before, you want to bound the position of all instruments to within +/- 180 contracts (for each instrument, you cannot short or long more than 180 contracts). Applying these constraints disallows the current position in the second instrument (short 182.36). All other instruments are currently within the upper/lower bounds.

You can generate these constraints by first specifying the lower and upper bounds vectors and then calling portcons.

LowerBounds = [-180 -180 -180 -180 -180 -180 -180 -180];
UpperBounds = [ 180  180   180 180  180  180  180  180];
ConSet = portcons('AssetLims', LowerBounds, UpperBounds);

To impose these constraints, call hedgeopt with ConSet as the last input.

[Sens, Cost, Quantity] = hedgeopt(Sensitivities, Price,... 
Holdings, FixedInd, [], [], TargetSens, ConSet);

Examine the outputs and see that they are all set to NaN, indicating that the problem, given the constraints, is not solvable. Intuitively, the results mean that you cannot obtain simultaneous delta, gamma, and vega neutrality with these constraints at any price.

To see how close you can get to portfolio neutrality with these constraints, call hedgeslf.

[Sens, Value1, Quantity] = hedgeslf(Sensitivities, Price,... 
Holdings, FixedInd, ConSet);
Sens =

       -352.43
         21.99
       -498.77

Value1 =

      855.10

Quantity =

        100.00
       -180.00
        -37.22
         80.00
          8.00
        -31.86
         40.00
         10.00

hedgeslf enforces the lower bound for the second instrument, but the sensitivity is far from neutral. The cost to obtain this portfolio is

Value0 - Value1
ans =

      22819.52

Portfolio Rebalancing

As a final example of user-specified constraints, rebalance the portfolio using the second hedging goal of hedgeopt. Assume that you are willing to spend as much as $20,000 to rebalance your portfolio, and you want to know what minimum portfolio sensitivities you can get for your money. In this form, recall that the target cost ($20,000) is treated as an inequality constraint during the optimization process.

For reference, startup hedgeopt without any user-specified linear inequality constraints.

[Sens, Cost, Quantity] = hedgeopt(Sensitivities, Price,... 
Holdings, FixedInd, [], 20000);
Sens =

      -4345.36        295.81      -6586.64
Cost =

      20000.00

Quantity' =

        100.00
       -151.86
       -253.47
         80.00
          8.00
        -18.18 
         40.00
         10.00

This result corresponds to the $20,000 point along the Portfolio Sensitivities Profile shown in the figure Rebalancing Cost.

Assume that, in addition to holding instruments 1, 4, 5, 7, and 8 fixed as before, you want to bound the position of all instruments to within +/- 150 contracts (for each instrument, you cannot short more than 150 contracts and you cannot long more than 150 contracts). These bounds disallow the current position in the second and third instruments (-151.86 and -253.47). All other instruments are currently within the upper/lower bounds.

As before, you can generate these constraints by first specifying the lower and upper bounds vectors and then calling portcons.

LowerBounds = [-150 -150 -150 -150 -150 -150 -150 -150];
UpperBounds = [ 150  150  150  150  150  150  150  150];
ConSet = portcons('AssetLims', LowerBounds, UpperBounds);

To impose these constraints, again call hedgeopt with ConSet as the last input.

[Sens, Cost, Quantity] = hedgeopt(Sensitivities, Price,... 
Holdings,FixedInd, [], 20000, [], ConSet);
Sens =

      -8818.47        434.43      -4010.79

Cost =

      19876.89

Quantity' =

        100.00
       -150.00
       -150.00
         80.00
          8.00
        -28.32
         40.00
         10.00

With these constraints, hedgeopt enforces the lower bound for the second and third instruments. The cost incurred is $19,876.89.

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