Derivatives Roundup: Simple, But Not Simpler

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.