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August 30, 2004 at 08:00 PM
NEEDHAM, Mass. (HedgeWorld.com)–Fixed-return options may fulfill some of the promises once optimistically attributed to single-stock futures, according to a recent research report from TowerGroup.
Senior analyst Matthew B. Bienfang began his report with the observation that the American Stock Exchange has proposed the listing of fixed-return options, products that already exist in over-the-counter transactions where they’re generally called binary or all-or-nothing options. The idea is that the buyer of a contract receives a payment of a certain amount if the stock price is above the strike price on the expiration date or nothing if it isn’t.
The key benefits that originally made single-stock futures (or “securities futures,” generally, including narrow-based indexes) seem attractive were, in Mr. Bienfang’s analysis, three: “The first is that they will allow investors to take positions in a more cost-effective manner [without margin lending or stock borrowing and their associated costs]. … The second characteristic is that the margin requirements set by the regulators are likely to make these products more capital efficient than trading in the underlying securities.” The third benefit is that single-stock futures may provide a favorable vehicle for overseas investors who want to put money into the capital markets in the United States, for reasons including tax exposure and currency risks.
Fixed-returns may share the first two of those benefits, although they don’t offer the same benefits for overseas investors that single-stock futures do.
On the other hand, fixed-return options have an important advantage over single-stock futures in that the systems required to support such a product exist already; institutions can apply existing binary models to the fixed-return option and the product is unequivocally equity, not an equity/futures hybrid. Fixed-return options are cash settled, too, so that although they lack the leverage of single-stock futures, they avoid any delivery risk.
Looking Back
With the benefit of hindsight directed at the period in which the legislative and regulatory groundwork for the listing of single-stock futures in the United States was laid (2000 to 2001), some of the enthusiasm seems exorbitant.
