Friday, July 23, 2010

eq listed derivatives desk

Some basic info from a friend –

Equity Listed derivatives – mostly options on single stocks or options on index/future, but also variance-swaps. Even if a stock has no listed options, we would still create a vol surface so as to price OTC options on it, but the technique would be different -- The standard technique if given many pairs of {expiration, strike} is to fit a curve on a single expiration, then create similar curves for other expirations on the same underlyer (say IBM), then try to consolidate all IBM curves into a smooth IBM vol surface. Each "point" on the surface is an implied vol value. I was told some of the more advanced "fitting" math is extracted out into a C++ quant lib.

Instrument pricing has to be fast, not multi-second. I guess this is pre-trade, RFQ bid/offer pricing, similar to bond markets' bid-wanted. In contrast, the more "real" need for vol surface is position pricing (or mark-to-market), which provides unrealized PnL. I feel this is usually end-of-day, but some traders actually want it real time. Beside the traders on the flow[3]/listed/OTC derivative desks, the vol surface is also used by many other systems such as structured derivatives, which are entirely OTC.

It's quite hard to be really event-driven since they are too frequent, instruments too numerous, and pricing algo non-trivial, exactly like FX option real time risk. Instead, you can schedule periodic repricing batches once a few minutes.

About 3500 underliers and about 450,000 derivative instruments. Average 100 derivatives on each underlier (100 combinations of strike/tenor). S&P500 has more than 1000 derivatives on it.

Market data vendors -- Reuterss, Wombat, Bloomberg.

Inputs to vol calculation -- product reference (strike/tenor), live market quotes, dividend, interest rate ...

One of the most common OTC equity derivatives is barrier option.

Pricing and risk tend to be the most mathematically challenging.

Exchange connectivity is usually c++, client connectivity (clients to send orders or receive market data) is usually java.

[3] Flow means agency trading, most for institutional clients. Retail clients are very wealthy. Those ordinary retail investors won't use an investment bank. Flow equity derivative can be listed or OTC.

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