Practical analysis for investment professionals
23 February 2012

Derivatives Roundup: Simple, But Not Simpler

Posted In: Derivatives

Could the derivatives market finally be listening to Albert Einstein? As you may recall, Einstein famously stated, “Make everything as simple as possible, but not simpler,” and according to the Reuters article “Simple Options Thrive in Risky World,” that is exactly what is happening. Simple, plain, vanilla options that hedge risk are beating out the more exotic, custom-designed option structures. Mikael Benguigui told Reuters, “There is a general consensus in the market now to avoid going into too-complex, too-exotic options.” This is a trend that definitely deserves future observation.

Elsewhere in the field:

  • How big is a swap dealer? Well the definitive answer may be . . . that depends. Initially, rules called for anyone trading more than $100 million in swaps to be considered a dealer. Now the CFTC and SEC seem poised to raise that number to $2 billion. As Gregory Meyer reported in the Financial Times, “Discussions about the limit was continuing and the figure could be revised before the vote.” What’s at stake? Swap dealers would have capital and margin requirements as well as disclosure and reporting responsibilities under the new derivative regulations.
  • Speaking of derivatives regulation, maybe we have it all wrong. Maybe we should regulate derivatives like the Food and Drug Administration (FDA) regulates drugs. In “A Proposal for Limiting Speculation on Derivatives: An FDA for Financial Innovation,” authors Eric A. Posner and E. Glen Weyl suggest that regulating derivatives like drugs will reduce the financial innovation of products that are designed to “facilitate gambling and regulatory arbitrage, both of which are socially wasteful activities.” Only when the instruments are proven to have social utility would they be approved for trading. Let’s see if this one catches on.
  • Finally, want to see how certain conservative option strategies have performed over the last quarter century? Well you are in luck. The Asset Consulting Group has just released “An Analysis of Index Option Writing for Liquid Enhanced Risk-Adjusted Returns.” The report reviews the results of the popular CBOE option index strategies for covered call writing (BXM and BXY), cash-secured put writing (PUT), and protective collars (CLL). There is just tons of useful information here (make sure you check out Exhibit 2 featuring the growth of one dollar for the various strategies). We will examine this report in detail in a future post.

For more news and trends, visit the Derivatives Community of Practice.

About the Author(s)
Bud Haslett, CFA

Bud Haslett, CFA, is executive director of the Research Foundation of CFA Institute and head of risk management and derivatives. Previously, he served as director of option analytics at Miller Tabak + Co., LLC, and as CEO of Miller Tabak Capital Management. Haslett also spent two decades on the options trading floor, where he managed portfolios of stocks and options. He also served as a board member of CFA Society New York, chair of the board of regents for the Financial Analysts Seminar, and president of the CFA Society Philadelphia. Haslett was an active volunteer for CFA Institute, having served in a variety of capacities, including as a CFA exam grader and member of the Council of Examiners. He has also taught coursework on options at New York University, Johns Hopkins University, and Rutgers. Haslett is the founding chairman of the derivatives committee for CFA Society New York and is a member of the Institutional Investor Advisory Committee for the Chicago Board Options Exchange. He has conducted option presentations and workshops at more than 50 CFA Institute societies. Haslett holds master’s degrees from the University of Pennsylvania and Drexel University, and he has earned the Financial Risk Manager designation. Topical Expertise: Derivatives · Risk Management

2 thoughts on “Derivatives Roundup: Simple, But Not Simpler”

  1. John Olagues says:

    Dear Bud :

    I would like to ask a couple questions of you.

    Fiduciaries have a duty to advise clients holding substantial positions in employee stock options to understand and reduce risk.

    Would you say that an employee holding 10,000 ESOs, with an exercise price of $50 and three years to expiration, has a greater chance of loss with the stock at $75 or at $115? Would you advise risk reduction at $75 or wait till $115?

    John Olagues

  2. Bud Haslett, CFA says:

    John,

    We do not give investment advice on specific positions here at the Enterprising Investor but perhaps you could think of the value of the ESOs at the two prices and what percentage of the client’s total wealth it represents and then make an informed decision about hedging. Please keep in mind that hedging need not be a digital, all or none event. Various degrees of hedging can be used at various prices if you deem it appropriate.

    Thanks for the question, and hope you enjoy future blogs on the Enterprising Investor.

    Bud Haslett, CFA

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