Built Lehman Brothers' DeltaOne structuration group, a $70 Mn a year activity
Continuously re-inventing the global DeltaOne franchise lead to an original and very successful structuration activity.
In effect, a significant part of the flow came in the form of very diverse and sometimes fairly complex structured products, as several hundreds of securities, OTCs and notes were created every year, ranging from plain certificates to dynamic-leverage, dynamic-underlying, multi-leg, multi-asset class instruments. Many such products were on the borderline of volatility and had exotic features like gap risks and triggers.
Different arguments have been put forward to explain the overall demand for and success of that activity:
· Underlyings which are better described as “Strategies” and/or “hedge-fund activities"
Example: The European Fundamental Values, a dynamic alpha-strategy based on earnings momentum and fundamental valuation reached one billion USD sales, and $30++ Mn profit, in first half of 2003 !
Example: The Free-Float Rebalance: an alpha-strategy based on trading “pressure”
· Underlyings which are actively defined by the customer during the lifetime of the product
Example: An underlying defined as an undisclosed long/short black-box led to a path-dependent but non-optional certificate
Example: Variable nominal swaps, sector allocation swaps
Cumbersome or tailor-made indices can be parameter-intensive
Example: The SXXR index is global index with a total return feature at unfavorable and country-dependent tax rates. The pricing of a 5Y certificate required the quick forecasting of 6,000 dividends enhancements
Example: Forwards / swaps on MSCI World
· Too often, option traders cannot hedge their Gamma-Vega exposure due to lack of liquidity or absence of listed market
· In such a case, the firm is better off trading an “option look-alike”: a derivatives, whose gearing is based on the underlying performance, which offers similar return profiles. Some well-chosen clauses turn this initially optional product into a non-volatilistic one
Keywords: Indices, weights, rebalances, corporate actions, MSCI
· Large baskets, large sizes or low liquidity make hedging more Program Trading jobs than option trading
· Some products have their added value in the execution of the hedge, like parallel executions of multiple legs for relative value derivatives
· The dividend risk requires quality forecasting, a typical cash-and-carry situation
· The tax risk requires an understanding of and an efficient cooperation with Equity Finance
· The execution of rebalances and expiries requires experience in communicating with compliance and authorities
· Large cash-and-carry positions generate specific unusual types of risks, often ignored by risk measurement systems
· Regulations, poor tax capacity, accounting imperatives or just MO/BO limitations often drive customers to alternative more cost-effective solutions
· Fund managers can thus easily gain and allocate exposure to underlyings or strategies which are unfit for options
· Since a good Excel can price and manage most, if not all, DeltaOne products, customers benefit from
-> a quicker pricing: no need for quant research or pricing model approval.
-> an approved termsheet on a new product in less than 24h!
-> an efficient secondary market, with real-time quotes published in a matter of minutes
Sales people are often blocked in-between traders and customers
· No subjective parameter (like volatility) brings transparency and accuracy from the trader
-> the best grounds for TRUST within the team
· The lack of stochastic theory makes the products easier to understand and approve
· A DeltaOne trading group allows option traders to focus on pure vol, while the DeltaOne trader handles parameter maintenance, complex hedge executions, liquidity issues, rebalances...
· Especially when the PL is made in the hedge execution, not in the pricing
· Equity Finance: sourcing/outsourcing inventory, yield enhancement
· PrimeBrokerage: specific customers with specific needs
· Fund Management: repackaging funds into derivatives to distribute to a larger audience
· Low VaR permits cheaper capital, and more margin on capital-intensive products
A few of many products and structure:
Example: Double-geared certificate with downside protection
Example: Long-short index with a lognormal (not normal) distribution of returns
Example: Total Return certificates
Example: Performance-driven leverage, to optimize an overall return profile, or approximate a CPPI
Example: Commodity exposure with an index-driven leverage effect
Example: Open-ended listed security on a discretionary underlying, with continuous management fees
Example: Hybridity between Equity / Fixed Income / Commodity
Example: DOT: deep in-the-money puts on single stocks, structured as debentures
Example: Derivatives on algorithms
Creativity, innovation, flexibility, credibility and professionalism have generated flows & volumes