Systematic Trading – The Official Guide to the CFST® Exam

By Alex Chaia

CFST® PROGRAM - THE CERTIFICATION THAT MATTERS

The CFST® Exam certifies trading professionals across the globe, providing hedge funds, market makers and other financial institutions in the derivatives industry the confidence that their talents are up to date with the industry and can demonstrate the knowledge required for everyday tasks.

Why would you ask for a CFST® Certificate?

COMPLIANCE

The test covers Trading Rules and Disciplinary procedures of multiple derivatives exchanges such as CME, LME, ICE, Eurex, B3, and the OTC regulations in critical jurisdictions. Successful applicants will demonstrate knowledge and control of the different regulations in multiple venues as require in a multi-asset business world.

PRODUCT

By covering multiple exchanges and OTC products trading characteristics and calculations, the test will certify that Traders and Brokers understand the differences and workings of each multiple product, qualifying them to be able to trade any derivative or to confidently deal with customer requirements in a wide range of product classes.

QUANTITATIVE

Level II of the CFST programme assesses candidate’s abilities with understanding the principles of algorithmic trading, strategy development and deployment. Questions will assess statistical, research, and infrastructure-related knowledge to certify a successful candidate to work in the industry.

Enroll for the CFST® Exam: www.prometric.com/CFST    

Level I is designed to cover Compliance, Market Fundamentals and Economics, and is suitable for all professionals in the derivatives industry, including Back-Office, Compliance, Trading, Operations and Sales.

Level II is designed to cover Derivatives Valuation, Risk Management and Algorithm Development and suitable for professionals in Risk, Trading and Strategy.

• Language: English
• Publisher: Austin Macauley Publishers
• Release date: Apr 26, 2024
• ISBN: 9781035815579

Alex Chaia

Alex Chaia is the managing director of Catalyst Futures. He is a professional derivatives trader with many years of experience across blue chip investment banks and niche start-ups. His professional journey focused particularly on currency and commodities derivatives. A graduate in quantitative finance, he spent part of his career in Sao Paulo, Frankfurt, Miami, and London. Some of the companies he developed his work with were Deutsche Bank, Citigroup, Raymond James, City Credit Capital and several consulting projects. Teams he worked with and played a key role have won awards from Institutional Investor Magazine, Agencia Estado in Brazil, Latin Finance and the Financial Derivatives Industry Golden Honour Awards in Shanghai.

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About the Author

Alex Chaia is the managing director of Catalyst Futures. He is a professional derivatives trader with many years of experience across blue chip investment banks and niche start-ups. His professional journey focused particularly on currency and commodities derivatives. A graduate in quantitative finance, he spent part of his career in Sao Paulo, Frankfurt, Miami, and London. Some of the companies he developed his work with were Deutsche Bank, Citigroup, Raymond James, City Credit Capital and several consulting projects. Teams he worked with and played a key role have won awards from Institutional Investor Magazine, Agencia Estado in Brazil, Latin Finance and the Financial Derivatives Industry Golden Honour Awards in Shanghai.

Dedication

To my father, Alexandre, In every sense, this book owes its existence to you. Your unwavering belief in the pursuit of knowledge has always been my guiding star. You taught me to question, to learn, and to dedicate myself to academic excellence. I can only hope that this work reflects a fraction of the wisdom and strength you instilled in me. With deepest gratitude and love, I dedicate this book to you.

Copyright Information ©

Alex Chaia 2024

The right of Alex Chaia to be identified as author of this work has been asserted by the author in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of the publishers.

Any person who commits any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

A CIP catalogue record for this title is available from the British Library.

ISBN 9781035815562 (Paperback)

ISBN 9781035815579 (ePub e-book)

www.austinmacauley.com

First Published 2024

Austin Macauley Publishers Ltd®1 Canada Square

Canary Wharf

London

E14 5AA

Acknowledgement

I would like to express profound gratitude to the many individuals and teams whose invaluable contributions shaped this academic work. Firstly, my deepest appreciation goes to my wife, Sabrina. Her remarkable talents in creating the illustrations for this book brought complex concepts to life and added an indispensable visual dimension to the text. Her constant support and artistic mastery significantly impacted the final product. My friend, John Murray, and colleagues, Neil Greaves, Joe O’Mara, Elad Hertshten, Sergio Gullo, and Andre Schierz, have provided crucial insight and guidance throughout this journey. Their extensive experiences with Hertshten Group and Futures First have enriched the discussions in this book, and their thoughtful comments and advice have been invaluable. Moreover, I would like to extend my gratitude to the teams at Hertshten Group and Futures First. Their collective wisdom and understanding of the industry helped to ground the academic perspectives in the book with practical applications and real-world insights. Finally, my heartfelt thanks to the team at Prometric: Amanda Millard, Johan van Antwerpen, Nicoletta Vullo, and Michael O’Reilly. Their unwavering assistance and support throughout the process have been crucial to the completion of this project. To everyone, your support has been a vital lifeline during this endeavor. This book is not only a product of my solitary effort but also a testament to the power of shared wisdom and collaboration. Thank you.

Chapter 1

Introduction

1.1 About the CFST Exams

Congratulations on the decision to take the CFST exam! The CFST (Catalyst Futures Systematic Trader) Exam is designed to raise the standard of qualification in derivatives trading, preparing the next generation of market makers, CTAs, broker/dealers and any other professional directly involved in the algorithmic trading business. To be a certified professional and receive the CFST designation, candidates must succeed in CFST Level 1 and CFST Level 2 Exams. Each exam has 40 questions presented in multiple-choice format. A score of 70% or higher is required to pass on each level. Successful candidates should answer at least 28 questions correctly on each examination. The board of examiners of Catalyst Futures have developed this textbook to deliver the knowledge required to pass the test and be confident. There are, nevertheless, numerous institutions that Catalyst Futures has accredited to prepare for the exam. Visit www.catalystfutures.com for an updated list of education providers.

1.2 The Exam’s Structure

The CFST Exams are delivered as multiple-choice randomised questions. Each test is made up of 40 questions randomly chosen from thousands. No single exam is ever the same. There is a time limit of one hour, with some time to practice and adapt, but no programmed pauses. Using your time effectively is part of the managerial skills required to be successful in trading. The CFST Level 1 includes questions that focus on the following areas:

Derivatives Compliance

Market Fundamentals

Economics

The CFST Level 2 focus on the following areas:

Futures and Forwards Pricing and Risk

Options Pricing and Risk

Data Analysis and Stochastic Methods

Algorithmic Trading Models and Systems Design

1.3 Preparing for the Exam

Reading the textbook is usually sufficient for most of the candidates. It is important to consider your level of experience in the industry, which might influence your level of exposure to the covered topics. Every person is different, but we recommend 50 hours of preparation by reading the textbook and doing the exercises. Most candidates who are successful commit a time to study and book the test well in advance; having a deadline is a proven method of helping candidates to achieve their goals.

1.4 Who Should Take the Exam?

The exams are designed to practitioners of the derivatives industry, this includes derivatives traders, brokers, algorithm developers, compliance officers who supervise algo trading and brokerage activities, risk managers, portfolio managers, FX dealers, exchange personnel and any other professional category who in one way or the other is involved in the business of systematic trading.

1.5 What Is the Score Required to Pass?

The certification is divided in two exams-CFST Level 1 and Level 2. Each level has 40 questions and to pass candidates must score at least 28 points. Each question is worth one point. A 28/40 grade means that a score of 70% or higher is required to pass CFST Exams.

1.6 Prerequisites

There are no prerequisites for the CFST Exams.

1.7 How to Schedule the Exam?

There is no requirement for a sponsor to take the exam, although many firms do sponsor their employees to take the CFST. You can schedule your exam at www.prometric.com/cfst.

1.8 What to Take to the Exam Centre?

Take a government ID with a picture, usually, a passport or driver’s licence. You will have access to an on-screen scientific calculator, so that you don’t have to bring one. Food and most electronic devices are not allowed in the test centre. There will be a facility for you to lock your items before the test, so do arrive at least 30 minutes before schedule for checking in.

1.9 When Do I Receive My Grades?

Your grades are given as soon as you finish the exam, appearing on the computer screen. You will be given a paper copy. If you passed both exams, you can request a printed or electronic diploma by contacting [e-mail]. The diploma will entitle you to become a member of the organisation, participate in the events and to use the CFST as a professional designation in your signature.

1.10 About the Book

The board of examiners at Catalyst Futures BV have developed the CFST textbook so that you have the knowledge required to pass the test, and to make sure that you are confident in the application of the knowledge during the exam. The writers of the book are experts in the topics covered and understand the techniques needed to improve your test results. You will find detailed explanation and exercises on each chapter to ensure you have mastered all the necessary topics. The book is accompanied by a test bank with 150 questions to reinforce the concepts. Answer the questions carefully to affirm the knowledge and avoid looking at the answers before you reach a conclusion.

1.11 About Catalyst Futures BV

Catalyst Futures BV is a company dedicated to test development and certification of derivatives professionals. We are based in Amsterdam with representative offices in Chicago and London. We prepare the book as well as training schools to prepare candidates to take the CFST exam. Our objective is to develop a better market with better trained professionals and to raise the level of ethics and knowledge in the derivatives industry. We are delighted that you have joined us in this journey and wish you all the best in your endeavours to become a CFST professional. To contact Catalyst Futures, visit us on the Web at www.catalystfutures.com.

Chapter 2

Derivatives Compliance

2.1 Ethics and Professional Conduct

Ethics is a system of moral principles and a branch of philosophy, which discusses good for individuals and the community. The word derives from the Greek ethos, which can mean habit, character, or disposition. The ethical system is in continuous change; for example, nowadays, concerns for a clean environment and discrimination of gender or race are a much stronger question than in the past. Being ethical means being moral and good and respectful of the values of the society of our times. Respecting the laws and religious freedom, sexual choices, freedom of speech, and respect towards all humans and the environment are necessary for any organisation member. A candidate can be disqualified or denied membership if not in compliance with these values. We expect members to act with integrity when carrying out their functions. Failure to do so will result in the expulsion of our organisation and the relinquishment of membership. Examples of not acting with integrity include (but are not limited to) the following:

Falsifying documents

Misleading a client about the risks of an investment

Misleading a client about charges and penalties

Misleading a client about performance

Mismarking the value of assets or trading positions

Misleading someone about the creditworthiness of a borrower

Providing false information

Failing to disclose dealings

Failing to rectify mismarked positions

Preparing inaccurate or inappropriate performance reports

Report performance without the necessary warnings

Giving inaccurate confirmations

Most regulators in major jurisdictions will require that the staff is appropriately trained, qualified, and regulated. They require a high level of competence in certain retail activities. In the US, the UK and European Union professionals need to maintain continuous training, with supervision requirements and specific obligations concerning retail investment advisers. Trading regulation usually encompasses recordkeeping and detailed knowledge.

2.2 US Derivatives Regulation

2.2.1 The Commodities Exchange Act and the NFA

The backbone of the American derivatives regulation is the Commodities Exchange Act of 1936. This Act replaced a law that was designed almost exclusively for Grain Futures in the 1920s. In 1975, Congress created the Commodities Futures Trading Commission (CFTC), the government regulator for futures and other derivatives. In some cases, such as stock options and single-stock futures, the Securities Exchange Commission (SEC). In the United States, the Self-Regulatory Organisations (SROs) are vital in the market structure. We highlight the National Futures Association (NFA), an SRO that began in 1982 when the CFTC defined them as the registered futures association. The NFA Rulebook is the essence of the industry registration and maintenance requirements. The NFA Rulebook is available at www.nfa.futures.org/rulebook.

Article III Section 1 of the NFA Rulebook provides us with the fundamental purposes of the association. In simplified language, we summarise the main objectives delineated in this article:

Undertaking the regulation of members

Relieving the CFTC from direct regulation

Adopt, administrate and enforce rules on member persons and firms (we will define these next)

Protecting the members and the market against insolvency, bankruptcy, unsafe or unsound conditions of other members

Provide arbitration or voluntary settlement mechanisms with fair and equitable procedures among members or customers

Adopt appropriate standards concerning training, experience and other qualification requirements to ensure the fitness of Members and Associates

Protect customers by governing how members conduct customer communications, how risks are disclosed, how transactions are handled, recorded, accounted and reported

The NFA conducts regular audits in its member firms and associated persons, reviews registrations, and requires consistent disclosures and information.

Any individual or firm that wishes to deal or arrange futures and other derivatives business in the United States must register with the NFA. The Online Registration System (ORS) of the NFA is where the security managers (usually the compliance officer of a member firm) file applications for membership registration, registration of associate persons (AP) and other administrative tasks. Each member firm and AP is assigned an NFA ID number. An associated person (AP) is an individual associated with a member firm that solicits customers (either by taking orders, funds, managing) or supervises persons engaged in these activities.

The NFA also established proficiency requirements for professionals registered with it. These are the Series 3-National Commodities Futures Exam, Series 30-NFA Branch Manager, Series 31-Futures Managed Funds Exam, Series 32-Limited Futures Exam and Series 34-Retail Off-Exchange Forex Exam. The exam requirements will depend on the registration intended and will mostly rely on the examinee’s actual tasks. To register with the NFA, APs must also provide their professional and residential history going back ten years or as far as possible.

Firm Types and Requirement

The NFA categorises member firms as follows:

Futures Commission Merchant (FCM) is an entity that solicits or accepts orders to buy or sell futures contracts, options on futures, retail off-exchange forex contracts or swaps. It receives money or other assets from customers to support such orders. FCMs must maintain an ‘Adjusted Net Capital’ as defined in CFTC Regulation 1.17; that amount is usually north of $2,000,000 and increases per the number of associated persons and branches the FCM has. They also must add 8% of the customers’ risk maintenance and margin/performance bond requirements for all domestic and foreign derivatives traded. When the FCMs are broker/dealers regulated by the SEC, the adjusted net capital follows Rule 15c3-1(a) of the Regulations of the SEC. For Swaps dealers, the ‘Adjusted Net Capital’ increases to $20 million. Forex dealer members must meet the requirements of Section 11.

Professional Hint: FCMs usually will do the math of how much they must put away to have a customer and charge more commissions on customers who hold overnight positions because of the 8% adjusted net capital requirement. Because shareholder’s capital comes at a cost and minimum return requirement, they will consider that they need to put 8% of the customer’s margins in addition and consider the cost of that capital.

Forex Dealer Member (FDM) is an entity that acts or offers to act as a counterparty to an off-exchange foreign currency transaction with a person who is not an Eligible Contract Participant (ECP). The transaction is either: a futures contract, an option on a futures contract or an option contract (except options traded on a securities exchange), or offered or entered into, on a leveraged or margined basis, or financed by the offeror, counterparty or person acting in concert with the offeror or counterparty on a similar basis. Forex dealer members must have the Adjusted Net Capital of at least $20 million, plus 5% of all liabilities owed to customers and 10% of all liabilities owed to ECPs and affiliates.

Retail Forex Exchange Dealer (RFED) is an organisation that acts or offers to act as a counterparty to an off-exchange non-US currency transaction with a person who is not an eligible contract participant, and the transaction is either: a futures contract, an option on a futures contract or an option contract (except options traded on a securities exchange); or offered or entered into, on a leveraged or margined basis, or financed by the offeror, counterparty or person acting in concert with the offeror or counterparty on a similar basis. The RFEDs are primarily subject to all regulatory obligations of an FDM, and most firms dealing with FX in the US are both FDMs and RFEDs.

Introducing Broker (IB) is an individual or organisation that solicits or accepts orders to buy and sell futures contracts, forex, commodity options, or swaps but does not accept money or other customer assets to support these orders. The IBSs must carry all forex and futures accounts, including customer, proprietary and foreign futures with an FCM or RFED on a fully disclosed basis. Introducing brokers are required to maintain $45,000 or more as Adjusted Net Capital. If the IB is affiliated exclusively with one FCM, then there is the possibility that the FCM acts as a guarantor, thus removing the adjusted net capital requirement.

Swap Dealer (SD) is an entity that engages in any activity commonly known in the trade as a dealer or market maker of swaps. Swap dealers must maintain at least $20 million of adjusted net capital.

Commodity Trading Advisor (CTA) is an individual or organisation that, for compensation or profit, advises others directly or indirectly about the value of or the advisability of buying or selling futures contracts, options on futures, retail off-exchange forex contracts or swaps. Indirect advice includes exercising trading authority over a customer’s account or giving advice through written publications or other media. CTAs must report capital ratios and detailed information of their books on a monthly and quarterly basis. CTAs cannot accept funds from customers. All accounts must be held with an FCM directly into the customer’s name, usually advised or controlled by the CTA via a power of attorney. CTAs do, in most cases (except in certain exemptions), have to offer the customers a Disclosure Document, indicating all costs, risks and potential conflicts of interests.

Commodity Pool Operator (CPO) is an individual or organisation that operates a commodity pool and solicits funds for a commodity pool. A commodity pool is an enterprise in which funds contributed by several persons are combined for trading futures contracts, retail off-exchange forex contracts, or swaps, or to invest in another commodity pool. CPOs must report capital ratios and detailed information of their books on a monthly and quarterly basis. As with the CTA, CPOs usually have to disclose costs, risks, and potential conflicts of interest and provide periodic statements and accounts reports to customers and the NFA.

Except on few exemption cases, CTAs and CPOs must prepare and file with the NFA a Disclosure Document that provides prospective investors precise and thorough information about the member firm, the trading programs, the manager’s performance, and the programs costs, the risks and conflicts of interests. This document must be filed at least 21 days before the distribution and must have the agreement of the NFA before solicitation of investors. However, the NFA does not guarantee the accuracy and truthfulness of the information provided. CTAs and CPOs must update the Disclosure Document every nine months to reflect performance and other details. The NFA publishes and updates a guide to CTAs and CPOs on how to prepare a disclosure document. You can access this document at https://www.nfa.futures.org/members/member-resources/files/cpodisclosure-documents.pdf or https://www.nfa.futures.org/ members/memberresources/files/cta-disclosure-documents.pdf.

The principal requirements for the disclosure are listed below:

Background and experience of the firm’s principals

The business history of the firm and principals for the past five years

Any regulatory action in the preceding five years

Performance data for the past five years and current year

If no performance or experience,