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nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-05-08 09:50
Couple of structured product intermediaries are asking me to build for them pricing and risk engines with mind to run their own book. I cooked up quickly some models with reasonable response already, but now facing dilemma whether to continue in this direction or not.

What is the feeling of community about the future of this market? Or maybe something else is more interesting and promising?

In the past I did serve structured and all kind of derivatives desks for several years from risk model and pricing validation part, so I am less familiar with market itself, hence the question.

Thanks.

kloc


Total Posts: 38
Joined: May 2017
 
Posted: 2020-05-08 10:24
What asset class? Equities, FX, Fixed income...? Geography?

I've been away from the market for some time, but IMO EQ structured products have been standardized/commoditized and the client base has been constistently only shrinking over time.

I'm sure there are occasional blips of hope here and there (and that maybe even light exotics for retail clients is still alive and well in HK), but gone are the heydays of selling structured notes with large notionals and juicy fees to institutional investors...

agentq


Total Posts: 40
Joined: Jul 2008
 
Posted: 2020-05-09 01:36
Here is an example of recent mayhem in eq derivs land. Many jokes I could make about this in particular, but the phrench are already the butt of too many.

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-05-09 11:24
Thank you, guys.

Assests: US Equity
Market: so far continental Europe incl. Eastern

There is a bit of problem with complex products. Risk forces pull bid-ask spread apart, while competition forces pull this spread down. The period of diminishing returns and increase of competition goes in correlation with increase of unrealized risk. Complexity obscures simple facts.

Is there single place monitoring the entire market of issue prices?

kloc


Total Posts: 38
Joined: May 2017
 
Posted: 2020-05-09 14:11
There were many attempts in the past (and there might be new ones, or some might still be around) to provide services which would give insight in light exotics pricing - things like down-and-in/out continuous KO puts, calls etc. The rationale was that the banks could submit their quotes for a range of light exotics products and then "compare notes" and see how their flavor of vol-model-of-the-jour compares to others' models. Totem submissions were one example which comes to mind.

The real problem is that EQ exotics is done OTC and no two structures are alike. At least date schedules differ, but usually coupon levels differ, autocall barriers differ, DI put strikes... no two are 100% the same and their risks and prices differ. You are always comparing apples to oranges to pineapples to cucumbers... Hence, there can be no "central" monitoring of these. They would have to be standardised, made fungible, and ultimately possible to listed on exchanges. But then they would be like vanillas and they would not be exotics any more.

Having said that, as long as EQ exotics exists, there should exist a need for independent pricing - be it from internal sell-side departments like risk dept's in banks, or from the buy side. If you are a portfolio manager sitting in a pension fund, and you are looking at this monstrous 10-Y autocallable structure, you need to know its risks and, ultimately, to independently know its price if you were to trade it. As a PM in such a place you won't have access to a full-blown quant modelling team - you will need some sort of external third-party price source. The bank which sold you the structure will offer to show the structure prices daily or even to show you (tentative) secondary market on it, but I think we both know how valid those prices are really going to be and how firm those secondary market quotes will be at the first whiff of you actually trying to unwind those positions.

So, although EQ exotics is IMO a dead-end as a business in the long run, it might be possible to have a viable consulting business offering some kind of 3rd party services like risk analysis and valuation. I'd also expect that a number of people who used to be in EQ derivatives have attempted or even succeeded in building businesses which provide such services.

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-05-09 19:52
@kloc

My intention (or maybe better dream) is exactly this - to have stable consultancy stream from them.

Totem! Right name. But I thought they are part of Markit for years.

Kitno


Total Posts: 496
Joined: Mar 2005
 
Posted: 2020-05-10 00:11
If you feel comfortable with their rationale for undertaking the business, do it. Else don't.

For me, structured products exist for people to screw over others.

Why does someone want to invest in VOD 5y credit risk overlaid with 2.15x FTSE performance between 19th April 2024 and 26th April 2024 subtracting 6x 2m SEK LIBOR (capped at 2.55%)?

On a laager on a hill. A long way from Avondale.

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-05-10 13:15
> Why does someone want to invest ...?

For me it is enigma as well... I always wanted to picture an "average" buyer of these products.

However, fair pricing is fair. What I see on front page of e.g. Leonteq looks plausible.
Basically, it is about sales "Implied vol" which is consistently more expensive than the realized one.

Risk management is key and not following its recommendation is destructive for both sides (see example from agentq), but that's the matter of the discipline of the front office we know that.

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-05-16 12:36
"Aarrgh!" ((c), quote from some old thriller-cartoon)

I crash into slowness of extraction of local volatility points from american options (I did fast implementation but with slowest performance ever... not a surprise).

Searched literature and see that the solution implies either regularization problem after which with have to apply arb-free smoother or solution like did De Marco in his "Local volatility from American options" from "Risk".

I know, it is an ancient problem from "Quant Renaissance ages", but got a bit outdated by using "someone else's tools" rather than building myself. Maybe I am missing something obvious.

Question is - what is the modern fast and simple to implement way to get locals from americans? (Please, no Trump jokes. ;)


sigma


Total Posts: 110
Joined: Mar 2009
 
Posted: 2020-05-16 19:11
>> Here is an example of recent mayhem in eq derivs land. Many jokes I could make about this in particular, but the phrench are already the butt of too many.

Interesting article.

It is not clear how did their equity desks lose so much on dividends.

If they sell autocalls they must be short delta, long dividend risk, which they should hedge by selling EuroStoxx dividend futures.

Was is because of the basis risk between single stock dividend and EuroStoxx dividend futures?



nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-05-16 20:04
All losses on divs are due to someone did not account for withholding tax (operational risk) or
some country changed that postfactum (legal risk)

sigma


Total Posts: 110
Joined: Mar 2009
 
Posted: 2020-05-16 21:03
Not only, there is always a dividend risk
For a hypothetical example, say you short $100 strike call on a stock with $110 spot and $10 dividend next day. The delta today is about 50%. If the dividend is canceled by the company by the end-of-day , all other things being the same, including the stock price, the call price will increase by at least $5. This is a gap risk due to dividend risk, that you cannot hedge with delta.

kloc


Total Posts: 38
Joined: May 2017
 
Posted: 2020-05-17 06:12
Few points:
(1) These were Asian desks - the underlying wasn't SX5E. Imagine the cost of hedging KOSPI dividends.
(2) Imagine the cost of *dynamically* hedging any index dividends.
(3) Imagine the cost of dynamically hedging dividends on *single* names on HKEX or KRW.

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-05-17 08:43
@sigma

True. I'm coming from the old "respected" delta one, so cannot imagine someone didnt take this into account. In those times we had separate reporting with stress 25% steps of dividends. So, these losses were considered.

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-06-06 10:10
[duplicate]

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-06-06 10:11
Seems that I have lost intuition.

My pricer returns autocallable coupon price as:
Price(guaranteed coupon) < Price(memory ON) < Price(memory OFF)

which is explainable because memory is soft version of guarantee.

However, market shows: Price(memory ON) > Price(memory OFF)

Am I wrong?


Strange


Total Posts: 1661
Joined: Jun 2004
 
Posted: 2020-06-06 14:23
It's both and will depend on the exact parameters of the note. The memory feature essentially accumulates the coupons from dates when coupon conditions have not been met and pays them out when coupon conditions are met. So it becomes a tradeoff between the value of the accumulated coupons and the value of optionality due to met conditions.

'Progress just means bad things happen faster.’

nikol


Total Posts: 1195
Joined: Jun 2005
 
Posted: 2020-06-06 16:24
@Strange

Spot(S), AutoBarrier (AB), CouponBarrier (CB), Strike (K), ProtectionBarrier (PB), LocalVol (LV) are fixed for both memory ON and OFF versions.
Assume also European, hence payoff at maturity is everywhere the same.

Therefore, I expect (CFs are discounted of course)
P(memory=ON) ~ coupon_rate * Num_of_coupons * Prob(CB < S < AB) + Payoff

condition is a bit more complicated, but ok

P(memory=OFF) ~ coupon_rate * Num_of_coupons * (1-Prob(kick out by CB)) + Payoff

Roughly (1-Prob(kick out by CB)) < Prob(CB < S < AB) , because we add probability to come back.


Guaranteed is when CouponBarrier = 0.

Autocall kick-out probability is the same in all cases.


thanks for reply.

day1pnl


Total Posts: 58
Joined: Jun 2017
 
Posted: 2020-07-04 20:41
High barriers to entry. The dealers who are there have been for 15years and been optimising each year. As kloc said, scrambling over a client base consistently shrinking over time. They cant get the entire client eco system needed to run Their greeks (correlation swaps) out even if you have a “pricing model”... which is why it is still banks running that business. but maybe im wrong.. maybe there will always be a market for ‘hard exotics’. But hard exotics are going out fashion and light exotics (no path dependencies, ‘light customisation’) is the future. The fees are not as fat as for hard exo and which is why I Dont see how below mentioned shop Can Do vertical integration into running those trading risks.

Edit: imo, more viable a bank simply buys a promising distributor / intermediary to get deeper in the supply chain. But maybe doing a bit of running your own risk is what puts you “on the map” to be bought.
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