Sunday, November 6, 2011

profit size, NOT market size, determines budget for a trading system

Q: what kind of market potential determines how much (salary and other) budget a bank has for a trading syste?


I don't know what factors are truly important but I know market size is not. Many people say Forex securities have gigantic market sizes in _notional_. If you hear anyone describing the (growing) importance of IRS, they never fail to mention total outstanding contract value.

If you ask me, global market __profit__ size (in dollar and cents) determines how much budget a bank allocates to given trading desk. (A bank typically aims to capture x% global or regional market share.)

Example -- FX options usually get quite a decent budget with much smaller aggregate contract outstanding than FX spot (B) [1], because FX option has fatter margin. FX spot margin is very thin due to competition.

Example, Equity volatility trades have lower aggregate dollar amount than cash equity (B) but fatter margin.

As yet another derivative example, I believe CDS was very lucrative and high-margin, compared to government bond (B) trading.

All of these trading systems get sizable budgets despite small market sizes compared to the bigger markets of (B).

[1] I'm not sure how to measure outstanding in FX spot, but it's probably fair to compare aggregate transaction amount in spot vs FX options. FX spot markets have large number of large trades.

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