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Steve Castle


Total Posts: 306
Joined: Sep 2010
 
Posted: 2011-12-27 19:19
Could anyone help me out with some resources on the practical details of trading equity swaps? I understand the valuation (at least the theory) and some basic usages (hedging, exposure transformation, structuring).

I guess I'm looking for more of the micro-structure details, and maybe some more advanced examples.

found this:
Attached File: Equity Swaps.pdf

Went through it and replicated all the examples, but I'm looking for more and have not found too much. Are they just too vanilla to be interesting? The attached PDF seems kind of naive in the pricing, but is that how it's done in practice?

Equity is out of my space, but I'm familiar with IR swaps and TRS on bonds. Same idea here, except equity fwds instead of rate fwds? Does it make sense to speak of an equity curve, or is it just the rate curve that matters?
[Edit]
Just found the answer to this last question, just the rate curve matters apparently
[/Edit]

I posted in trading because I'm more interested in the trading perspective than the pure valuation and getting at the details of trading these.

Thanks for anything you can provide.

in the words of one such quant ‘were on the whole either less quanted or not quanted at all’.

afekz


Total Posts: 30
Joined: Jun 2010
 
Posted: 2011-12-27 22:07
Hi Steve,

I'll share my $0.02, though I wouldn't say that my experience necessarily covers all scenarios/usages, so treat my comments as a single datapoint in your set.

In my experience, equity swaps are a structuring tool that may offer some kind (or kinds of) regulatory benefit over the holding of physical securities, which benefits vary from jurisdiction to jurisdiction. Examples of these include access to higher leverage than would ordinarily be permitted to the equity receiver (effectively the equity hedge for the swap is financed on balance sheet by the equity payor/writer), access to foreign market returns without directly registering with a local broker, economic avoidance of stamp duties in markets where trades are subject to these duties but broker-dealers benefit from market-making and/or derivative-related exemptions, reductions of withholding taxes in a variety of jurisdictions, differing capital requirements treatment for certain classes of regulated investors, et cetera.

In their simplest form, they're pretty much like retail CFD's, where often the writer will not write a contract unless and until they have priced and purchased or alternatively received by delivery the equity hedge, or alternatively have entered into a back-to-back swap with a market participant local to the market of the target securities - their job is *generally* not to take on market risk

Apart from the structuring of custom deals, global hedge funds may often make use of equity swaps with a single prime brokerage counter-party to obtain a single point of interface, reporting and credit risk management for global portfolio trades.

Keep in mind that the current environment is less agressive than it has been in the past. Equity swaps have also previously been used to avoid triggering ownership disclosure requirements - I think either equity swap arrangements and/or cash settled options were used by Porsche with its approach on VW.



Steve Castle


Total Posts: 306
Joined: Sep 2010
 
Posted: 2011-12-27 23:16
Thanks afekz, welcome to the forum.

Any chance you had experience running a book, or know what the common issues would be?

It seems like a pretty vanilla swap business, but I'm not sure if that's because im so ignorant.

in the words of one such quant ‘were on the whole either less quanted or not quanted at all’.

granchio


Total Posts: 1540
Joined: Apr 2004
 
Posted: 2011-12-27 23:55
I knew people who run such books on the sell-side, and was a little bit involved in parts, so my 2 cents...
Clearly, they would be part of delta 1 trading groups.
As in all delta 1, balance sheet management is probably a key consideration/aim/risk.
From pricing/risk point of view, once you have decent system you will be focusing on your forwards (in particular dividends and taxes), discount factors (i.e. funding) and counterparty.
Having decent systems sounds easy, but is not trivial.

"Deserve got nothing to do with it" - Clint

afekz


Total Posts: 30
Joined: Jun 2010
 
Posted: 2011-12-28 15:46
My exposure to this arises primarily from several ad hoc projects I've been engaged on with one of the larger international banks, working with their local synthetic prime business and delta one equity derivatives desk.

In my experience the non-vanilla stuff primarily relates to the structuring aspects, rather than the trading/hedging. There may be some sell side trading opportunities around where one is dealing with equity index swaps - hedging with cash, futures, tracking portfolios, etc - but I don't see where OTC equity swaps would offer much in the way of trading opportunities to the buy side. They're more of an efficiency/access tool, with a lot of benefits to both counter-parties.

The additional complexity of trading through a swap shouldn't be substantial, nor should pricing be much of an issue, I don't think.

However, as I point out above, my exposure has been sell-side with one bank primarily in one jurisdiction, soooo.... *shrug* =)

Steve Castle


Total Posts: 306
Joined: Sep 2010
 
Posted: 2011-12-28 16:00
Thanks guys, that's what I wanted to know.

in the words of one such quant ‘were on the whole either less quanted or not quanted at all’.

HitmanH


Total Posts: 461
Joined: Apr 2005
 
Posted: 2011-12-28 16:10
Confirmed from my info.

Buy side use - mainly for access, leverage, simplicity, reg arb - as been stated.

Sell side - the 'problems' are on the structuring and hedging. Structuring isn't a big deal of 90pc of what is done (single names, defined indicies etc), but comes into it when a client is wanting a custom basket - and then the rules that they may want on exposures - re-balancing etc. So similar issues you'd get on an index product - but here - the bank needs to be able to model it - price it (not hard, but systematically it could be so), and hedge it.

That leads onto the next issue - hedging. Expanding this beyond single names - and think standard delta one desk. Have you look at correlations, contributions to indicies - and bank's risk appetite. May have futures, swaps on the index, plus ETFs, plus various custom baskets (index minus arms/tobacco etc), major constituents etc.

Most banks will project betas of these onto the desk (don't let desk change) - say you can have intra-day directional exposure of $$, and end of day of $ - and can hedge either using 'true' beta & delta 1 products (what i'd imagine is if you sell futures to a client, you buy them in to hedge, and if you buy an ETF from a client - you sell it on) - or look at those betas/correlations - know what you're exposed to (single name wise).

Interestingly -it's in how far you push this that you can see how Dodd Frank on a delta one desk is interesting - what is pure customer trading - and what is prop - all down to the degree of freedom the desk has...

A useful function of d1 is inventory - esp if the bank has a prime brokerage department. A client (lets say you can't buy a future) buys a FTSE 100 swap. You on the desk decide that the best way to hedge that (and you probably wouldn't) is to buy every name. So on your book, short swap - long individual names. With these names - there's no need to keep them - can loan them out to the clients of the bank wanting to short (via the prime brokerage department) - and earn another income for the desk.

Beyond that - child's play stuff - credit risk - to be handled by standard CSAs - modelling isn't hard - but as people have said - systems need to be tight - and to capture all funding, borrow etc costs.

Steve Castle


Total Posts: 306
Joined: Sep 2010
 
Posted: 2011-12-28 18:50
Thanks again!

in the words of one such quant ‘were on the whole either less quanted or not quanted at all’.

Jurassic


Total Posts: 106
Joined: Mar 2018
 
Posted: 2018-07-15 21:22
> As in all delta 1, balance sheet management is probably a key consideration/aim/risk.

@granchio What does balance sheet management actually mean?

nikol


Total Posts: 461
Joined: Jun 2005
 
Posted: 2018-08-14 17:24
Balance sheet management = overall Asset Liability (incl. Liquidity) + Risk (Equity) vs Reward management

Jurassic


Total Posts: 106
Joined: Mar 2018
 
Posted: 2018-08-15 19:45
@nikol isnt that the same for any desk?

nikol


Total Posts: 461
Joined: Jun 2005
 
Posted: 2018-08-17 10:54
You can treat your desk as a small bank. Only exception is that your funding might be better (internal subsidy) than on the market.
Equity swaps, TRS and ASW, are about funding (incl. XVA) + repo.
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