Introduction to Equity Derivatives
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1 Introduction to Equity Derivatives Aaron Brask + 44 (0) Internal use only
2 Equity derivatives overview Products Clients Client strategies Barclays Capital 2
3 Equity derivatives products Equity Swaps Investor pays LIBOR + spread and receives performance of underlying Vanilla options Call and put options Variance swaps OTC contracts to buy/sell the realised variance (volatility squared) on an underlying Dividend swaps Correlation swaps OTC contracts to buy/sell the dividends of companies without investing directly in the companies OTC contracts to buy/sell the average realised correlations amongst a basket of stocks Structured products 3 Customised solutions for specific clients
4 Equity derivatives overview Products Clients Client strategies Barclays Capital 4
5 Equity derivatives clients Institutional investors Corporates Eg, portfolio managers. They are often benchmarked to a given index and generally need to protect themselves against adverse market moves. Treasury functions such as financing and stock options programs require equity derivatives solutions. Retail / private banks and investors Investors are attracted to customised structured products that are made up of derivative components. Hedge funds Generally take advantage of pricing anomalies that surface as a result natural flows. 5
6 Client decision making Institutional investors Larger decisions can take weeks/months as committees deliberate. Smaller ones can be executed on the spot. Corporates Generally much collaboration on a customised solution which can take months or longer. Retail / private banks and investors Could be days or weeks depending upon their mandate and customer demand. Hedge funds Generally the quickest and they execute in good size. Custom risk transfers might take longer. 6
7 Equity derivatives overview Products Clients Client strategies Institutional Corporate Retail / private bank clients Hedge funds Barclays Capital 7
8 Client strategies overview Institutional investors Put protection Collars Call overwrites Hedge funds Leverage Volatility trading Corporates Buybacks Financing Compensation Retail / private investors Structured products Eg, capital guaranteed notes 8
9 Equity derivatives overview Products Clients Client strategies Institutional Corporate Retail / private bank clients Hedge funds Barclays Capital 9
10 Institutional investors (real money) Put protection Collars Risk aversion Regulatory constraints (eg, stress testing) Mitigates cost of protection Sacrifice upside potential Call overwrites Generally done on stocks Generates income Other strategies Eg, 1x2 call spread overlays Sell further upside to amplify smaller returns * All strategies presented as overlays (ie, assuming client already holds the underlying). 10
11 Equity derivatives overview Products Clients Client strategies Institutional Corporate Retail / private bank clients Hedge funds Barclays Capital 11
12 Corporate equity derivatives Buybacks Selling puts Eg, Vodafone Financing Rights issues Convertible bonds Compensation Employee stock option programs (ESOPs) Eg, Microsoft Assets Debt Equity Convertible issuance, rights issues, ESOP 12
13 Equity derivatives overview Products Clients Client strategies Institutional Corporate Retail / private bank clients Hedge funds Barclays Capital 13
14 Retail / private investors (structured products) Investors want upside participation but worried about directly investing in equity markets Large demand to provide tailored exposures to equities as well as other assets (eg, commodities) Example: Total investment of 100 over 5 years Invest 70 in a zero coupon bond that matures to 100 in 5 years Allocate remaining 30 in (at-the-money) call options on an underlying asset (or basket of) 14
15 Example: Capital guaranteed note in pictures? Index options Zero coupon bond 100 Payoff Today 5 years later 15
16 Equity derivatives overview Products Clients Client strategies Institutional Corporate Retail / private bank clients Hedge funds Barclays Capital 16
17 Hedge funds Some use options as a means of leverage but most primarily speculate on volatility Strategies include Volatility relative value Dispersion / correlation Skew trades Dividends One general trend is to take other side of some of the asymmetric flows For example, volatility skew: Empirically, markets go up over time, but downside options (puts) cost more than upside options (calls) 17
18 Volatility dimensionality Index vol is lower but term structure is steeper Volatility is not just a single number Index or single stock Choice of strikes (and call or put) Choice of maturity * Stock vol LHS, index RHS Lower strike implied vols generally higher * x-axis = strike as % of spot 18
19 Volatility related flows Index volatility generally in demand Protection buying Structured products (participation) Stock volatility generally in supply Call overwriting Structured products (yield enhancement) Convertible bonds / buybacks Implied correlation generally elevated as a result of these flows (equivalent to saying index volatility is rich relative to single stock volatility) Volatility Call overwriting Structured products Convertible bonds Stock vol Index vol Structured products Protection buying 19 Time
20 Equity derivatives overview Products Clients Client strategies Barclays Capital 20
21 Equity Derivatives within Barclays Capital Clients Sales Trading Flow Hedge funds, prop desks, fund managers, pensions, insurers, endowments, corporates, retail + private banks, etc. Coverage split between client, regional, and product focus Exotics Delta-1 Structuring Arbitrage Research Equity derivatives research is divided amongst regions but coordinated globally. Supports sales, trading and clients. 21
22 Equity derivatives research Research website Equity derivatives research 22
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