FT Alphaville moderated a panel on “The rise and rise of Delta One” at the FOW European equity options conference in Amsterdam on Friday.
There was an excellent range of speakers representing a good slice of the Delta one industry in Europe, from market-makers to providers, to derivatives strategists.
Many thanks, consequently, to Bart Lijnse, managing director at Nyenburgh, Stuart MacDonnell, equity derivatives strategy at Citi, Martijn Rozemuller, managing director at ThinkCapital Asset Management and Keshava Shastry, director, Blackrock iShares for taking part and sharing their views. And also to FOW’s Aza Benyatov for organising.
Alas, we only managed to scratch the surface of the topic.
But here is the main takeaway for us. It’s one of the hottest areas in banking; yet, search for Delta one in any financial news database and you’ll either get a) appointment news b) stories about Jerome Kerviel and/or c) stories about the Nigerian Delta.
Ask someone from outside the industry to define Delta one, and you’ll struggle to get a cohesive answer. Ask the industry to define it, meanwhile, and you’ll get a multiple of different explanations.
And that’s because Delta one means different things to different people. Every financial institution seems deeply involved — all the usual big-name suspects, and many smaller names you might not have heard of too.
But each financial institution views the sector uniquely. Some sit their Delta one teams on their equity desks, others in prime brokerage. Some are pure brokers or market-makers. Others are more focused on the funding side and/or motivated by the needs of their asset management or structured products divisions. “It really depends what the institution’s strengths are,” said one industry source.
From a product point of view it’s simple. Delta one equals ETFs, sector swaps, dividend swaps and thematic baskets. It can include warrants and options too. Anything really, providing it involves returning a one-to-one performance to your client.
What many might not know, however, is that Delta one is just as much about repo, securities lending, funding and centralised execution as it is about the products themselves. It’s flow, but it’s also prop.
Though JP Morgan probably put it best when they simply described it as “flow-prop“.
The money is made just as much from taking a view with innovative hedges (the cheaper the better) as it is from margins and client fees.
Although ask a Delta one initiate about the nature of his hedges (or lack of them in the case of Jerome Kerviel) and you’ll not be met with many forthcoming responses. Are they secretive? You betcha.
While they’re more than happy to talk about the products they’re providing to clients, it gets awkward when you start asking about the processes used for facilitating them or how optionality is deployed.
Which is fair enough and unsurprising. It’s proprietary. It’s the secret sauce for making money out of all those branded-packaged products on the market. It’s where the magic of arbitrage takes place. Or as one participant told us: “it’s just what has always been thought of as trading.”
What makes any Delta one trader successful is thus a canny blend of market timing (including HFT and algorithmically-assisted timing), innovative hedging, access to funding and flow. Interestingly, more often than not, a stock’s direction is entirely irrelevant to the trader, or so we are told — especially when it comes to trading the dividend side of the market.
And while in the US the market has developed from the arbitrage opportunities presented by ETFs and swaps, in Europe the focus has been much more on dividend-related products. That’s partly to do with the way the ETF industry has developed in Europe versus the US (a greater tendency towards vertically-integrated provider models focused on synthetic rather than pure replication, which entrap the ETF opportunities internally) and partly because dividends play a much greater role in Europe, generally.
But one thing that really struck us from Friday’s discussions was the role that the retail/institutional client base plays in supporting Delta one’s existence in the first place. As one trader put it to us “it’s the petrol that fuels our industry”.
That’s not to say there isn’t any concern about the market’s current structure in Europe or level of transparency.
While further fragmentation through the listing of yet more lookalike products was seen as good for arbitrage, most participants agreed it wasn’t healthy for the market’s development. Concerns were also raised — quite vocally — about incentive fees in Europe when it came to distribution of products.
But what exactly was deemed to be fair game on a wider level?
According to the industry, as long as investor education is prioritized in the marketing of Delta-one products to both retail and institutional clients — the closed-shop mentality behind the trader-focused plumbing of the industry is and can be totally justified. Most agree, however, that investors must be made aware of exactly what it is they’re buying, how it performs and where the counterparty risk may lie. This is especially true in the case of non-delta one leveraged and inverse style products. And all agreed the more education the better.
Now, if those conditions are continually met, there’s unlikely to be much to stand in the way of either the ETF or dividend swap/futures market’s development in the short term.
Which means, when it comes to the future of equity trading — think Delta one.
