So I was wondering if anyone here has experience working on an equity swaps desk. In particular I am curious how a sell side trader might go about hedging a future anticipated order. The example I am getting at is the Leveraged ETFs which must rebalance as close to the close as possible. When the ETF buys swaps the bank is selling swaps and hedging by buying stock. Alternatively they can find another counterparty like a HF. If they are long swap exposure currently they can simply sell from their inventory. If anyone has experience in equity swaps please correct me where I am wrong with this process. Mostly I am interested in what the sell side trader is doing to hedge.
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Hedging is not as big a problem as you might think with equity swaps. Because of the OTC nature the traders usually have time to long/short the stock at the most favorable prices and then pass the prices onto the client with commission. The process for setting up the agreement is different in reality than the way you present the problem.
Acquiring/selling the stock through inventory or the market is the most common and easiest way of hedging equity swaps.
Most profitable as you mention would be to sell the swap onto another institution, you get 2X commission(Spread) + 2xIR markups(markdown) on notional. But this can be hard, often the security traded in the swap is illiquid or huge volume.
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I realize that hedging isnt a problem per se but rather my question is. Is the sell side trader anticipating an order to buy swaps later in the day and thus they have began buying stocks at favorable prices as you mentioned. I am concerned primarily with the end of day movements and added volatility of the final half hour of trading in financial names. This strong move late in the day with strong volume could be the banks waiting till the last minute to hedge? I am building a trading strategy that works around these ideas and positions me to take advantage of the added volatility in financials in the last half hour but I wanted to understand the mechanics of equity swaps because I feel that the leveraged ETF funds are major players.
"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.
trade4size - I always enjoy your insights and comments. this is a great post.
I'm not really familiar with this market, but I'd be curious to know what spread the counterparty (short the index/stock) is receiving these days.
You're not the only one trying to do this trade, and you don't have nearly the same information that the instituional guys have. They know precisely the size and time of the rebalancings.
It also won't always work: http://adamsoptions.blogspot.com/2009/04/rebalance-this.html
But I like the creative thinking.
I realize that the big boys have superior information so I must be able to react to this type of move more than anticipating. Im ok anticipating the move as long as I can define my risk before I enter and know where im getting out. The fatal flaw of the big boys is their sheer size... It takes them time to get into and out of position as a prop trader this is one of my edges since I can be nimble enough to bail out of the trade and be flat in seconds.
I have been reading that blog for a couple days as I have researched this type of trade. I am not trying to do the exact type of trade that the big boys are doing. I have a unique spin on how I want to implement it. That is another edge.
The most recent post references the flip flopping out of FAS into FAZ. I have never been one to flip flop often and almost every time I do I end up getting burned.
"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.
Bumpppppp. Come on wso I know there are some smart monkeys out there that would like to discuss some ETF gaming.
"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.
Help me understand equity swaps (Originally Posted: 12/30/2007)
I understand the scenarios where individuals would benefit from rate swaps and currency swaps.
Can anyone provide a scenario that would help me understand equity swaps? How would an individual or firm benefit from hedging equity price risk? How can this be done successfully? Do equity swaps involve single stock exchanges or index to index exchanges?
Thank you for your help.
one reason to do an equity swap is because you want long exposure to a company that you cant buy because of regulations- maybe MSFT wants to put its huge cash position to work to long AAPL but wants to avoid anti-trust issues.(not a great example maybe) So by organizing an equity swap they get the long exposure minus a fee to the bank without actually taking an ownership position in the company.
Thank you for that interesting idea. I had not thought about that!
Any others?
How would I pitch an equity swap to an investor? Why would they want to do an equity swap / how is it in their interest? What problems does it solve?
good topic, bump
hmmm, some ideas?:
Aren't equity swaps typically based on a stock index performance? It can just be a way to diversify income streams, using the stock market index as the variable income stream. If its on just an individual stock, dividend taxes would hit the stock owner rather than the counter party in the swap. Tax reasons could be one reason then.
For a bank, however, its pretty clear that using an equity swap is a way for them to buy the asset and use swaps in order to make loot off of spreads and commissions while being neutral. I.E. selling a stock to a client, entering into a swap agreement with them to pay them the dividend income, and owning the same asset to hedge risk.
...I'm a junior applying for SandT and that was my best guess.
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