Equity derivative products

Hello team,
I wondered if anyone can give any real-life explanation on any of the following equity based products:
- FVAs
- Swaptions
- Corridor Varswap
- synthetic covariance swap
- Geometric dispersion
- CVS
- Quanto option
- Correlation swap

Input would be much appreciated and could even spark a lively discussion.

Thanks
Bondy

 
Most Helpful

Since I am waiting for someone, here you go. Firstly, are you sure these are all for equity derivatives space? Some are pretty uncommon and more frequent in rates or FX. I rearranged them by commonality and degree of difficulty, will do half now and half later when I am drunk enough:

  • CVS (I think you mean CvC) Call vs Call, a basket of calls against a call on a basket. The simplest possible way to trade correlation (well, covariance).

  • Quanto option An option that tracks an asset but pays out in a different currency difference from the domestic currency of that asset. E.g. an Dec put on SPX struck at 2500 where both the premium and the payout will be in Eur. Obviously, correlation between the asset and the currency will matter a lot :)

  • Corridor Varswap It's a variance swap that only accrues variance on the days when the index is in a specified range. A regular variance swap pays off (realized_var - strike^2)vega_units where var units are vega_notional/(2strike) and realized_var = sum(ret^2)/n. So your payoff in a corridor swap would be similar (realized_var_in_range - strike^2)mod_vega_units where var units are (n_in_range/n) * vega_notional/(2strike) and realized_var = sum(ret^2 in range)/n_in_range. Usually these are done to take advantage of the steep skew - e.g. you'd sell a "100% down-var" where you only accrue variance if spot is under current 100% and that obviously would be pretty expensive.

  • FVAs - forward volatility agreement. It's an agreement to buy or sell a forward starting straddle, e.g. you agree to buy a straddle on SPX that will strike in 1 month and expire in 2 month. You rarely see them trade, to be honest these are more common in the FX world.

  • Swaptions - I assume we are talking about variance swaptions, considering the below. It is right to buy (receive) or a right to sell (pay) in a variance swap, e.g. I buy a Dec/Mar receiver swaption struck at 12 means that I will have a right (but not an obligation) to enter into a variance with these parameters. FYI, there are also equity swaptions, which are options to enter into an equity swap and rate swaptions which are options to enter interest rate swaps. The idea is the same, but the risk is very difference .

  • synthetic covariance swap Well, thats a swap that pays you covariance between several assets vs a fixed correlation*average_vol. You can think of it as a basket of variance swaps against variance swap on the basket (it kinda decomposes to that). Unlike the correlation swap below, can be priced and decomposed better. Very expensive, very hard to find dealers to quote, nearly impossible to get out. Usually dealers push these onto clients when they want to lay off some correlation risk.

I have a friend who lives in the country, and it's supposed to be an hour from 42nd Street. A lie! The only thing that's an hour from 42nd Street is 43rd Street!
 

Thank you very much mate! Helped a lot. I understand math behind it, but it is still very difficult to know why/when and how (in the scope of markets) certain products work.

Hope you had a good night (obviously must have had ;)).

If you have the chance to explain Geometric dispersion that's maybe the toughest so far. And yes they are all for Equity (some Xasset).

 
Bondy:
If you have the chance to explain Geometric dispersion that's maybe the toughest so far.
In a regular dispersion trades (CvC or vol swap dispersion etc) if any asset in the basket outperforms a lot in terms of realized volatility, is will start to dominate the volatility of the basket, thus negating the whole correlation aspect. Geometric average dispersion ensures that all components of the basket retain an equal weighting.

Since most exo desks are short correlation up the wazoo, the bank structuring desks are trying to pitch geometric dispersion to funds since it's a better layoff structure. From a volarb PM perspective, it's a worse trade than arithmetic dispersion (a simple backtest will show you that) - you don't get the single name vol convexity aspect that you get with arithmetic dispersion.

so, you gonna be a fresh monkey on an equity exotics desk? may I ask which desk?

PS. apparently, autocorrect thinks "volarb" is "vile Barb" :D

I have a friend who lives in the country, and it's supposed to be an hour from 42nd Street. A lie! The only thing that's an hour from 42nd Street is 43rd Street!
 

sorry, i had the ideas part as a constant. I get your flow though..

i always wondered though... For some instruments like the leveraged etf, is it the Client who comes up with the idea and then seaches for the bank who can best structure the deal and mitigate risk, or is it the other way around, whereby the sales teams pitches the idea to say Horizons Betapro... that part always was a little shady for me...

 

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