Derivative Instruments

Derivative Instruments - Articles & White Papers

Professional and academic papers on derivative instruments. Futures, options, swaps, forwards and OTCs can be great tools for fund managers, and much of the research in this section addresses practical issues relating to their use. Overlay strategies can be used for: managing risk, adding leverage, maintaining equity beta, market timing, controlling risk factor exposures or for transition management. Index futures can be used for TAA strategies; derivatives can be used for fixed income overlay strategies; interest-rate futures can be used to manage interest rate risk; and currency forwards can be used to manage currency risk. All of these themes are covered in articles and reports in this section. Of course the use of derivatives in the front office throws up operational challenges for the back office, whether in collateral management, margin management or in fund accounting. Indeed the pricing of options in particular is a key challenge, and many papers on this section focus on option pricing, for instance Nassim Taleb's paper explains that options traders use sophisticated heuristics - never Black-Scholes-Merton! A key concept in options pricing is that of implied volatility. Volatility research in this section includes reports on: volatility as an asset class, the volatility of volatility, the VIX index, and investing in short volatility (VXX). Other popular futures and options white papers in this section cover hedging portfolio strategies, optimal portfolio construction, derivatives regulation, rebalancing using options, inflation hedging, the Black-Litterman model, central clearing, counterparty risk and systemic risk.
  • Eaton Vance

    Managing equity portfolio volatility by harnessing the volatility risk premium (Eaton Vance, May 2017)

    After eight years of stock market gains, many investors have tempered their return expectations and are focusing attention on how best to best achieve equity-like returns with less risk. One relatively new solution investors are exploring is the use of option-based strategies that seek to harness the Volatility Risk Premium.

  • Lazard Asset Management

    Predicting Volatility (Lazard, 2015)

    It is widely accepted that financial models always carry the risk of uncertainty. Volatility forecasting, therefore, has huge implications for investors especially employing risk parity, volatility targeting and asset allocation strategies. This paper examines volatility prediction - its characteristics and the effectiveness of different approaches.

  • Manipulation in the VIX? (2017)

    At the settlement time of the VIX Volatility Index, volume spikes on S&P 500 Index (SPX) options, but only in out-of-the-money options that are used to calculate the VIX, and more so for options with a higher and discontinuous influence on VIX. The authors investigate alternative explanations of hedging and coordinated liquidity trading. Tests including those utilizing ...

  • T. Rowe Price

    Equity Market Volatility: It's Quiet Out There, Too Quiet (T. Rowe Price, Apr 2017)

    While investors continue to enjoy strong returns from global equities, one nagging source of discomfort is the remarkably low level of volatility being displayed by markets, especially given the uncertainties that remain ahead on the macroeconomic, political and corporate earnings front. This perspective is demonstrated by the MSCI AC World Index returning +7% for the year-to-date ...

  • We Don't Quite Know What We Are Talking About When We Talk About Volatility (Nassim Nicholas Taleb, 2007)

    This 2007 paper from Nassim Nicholas Taleb and Daniel Goldstein explores the apparent confusion between mean absolute deviation and standard deviation. The mental confusion between these variables has a significant impact on the perception of market "volatility" and hence decision-making. In markets which exhibit fat-tail characteristics the underestimation ...

  • Operational challenges facing investment managers in 2015 (Swift)

    This 25 page report is based on a survey of the heads of investment operation and fund distribution at large asset management companies. The report discuss the impact of regulation upon fund management companies, the risks associated with outsourcing, and issues surrounding corporate actions, collateral management, trade processing and fund distribution.

  • NEPC

    Overlay Strategies: Increasing Portfolio Diversification Through Derivatives

    • 09 Feb 2015
    • Company: NEPC

    NEPC argue that derivative overlay strategies can offer a variety of benefits, including securitizing idle cash, maintaining policy target exposures, and managing portfolio transitions. Overlay solutions may also help manage currency risk, equity beta or, interest-rate risk. As well as improving portfolio efficiency overlay strategies also seek to keep costs low through the use of ...

  • PH&N Investment Services

    Fixed Income Overlay Strategies

    The authors of this guide provide some insight into the global landscape for strategic-beta ETPs. They expect this niche to expand much faster than both the wider ETP market and the fund management industry as a result of new launches, cash flows, and industry players. 

  • The Fundamentals of Commodity Futures Returns

    The risk premium associated with commodity futures will vary over time and across commodities, depending on the level of physical inventories. A number of issues reflect the true state of inventories: price measures, prior spot returns, price futures returns and spot price volatilities. The authors check these predictions using a detailed dataset on thirty-one commodity futures and ...

  • The Black-Litterman Model in Detail (2011)

    In this paper, the Black-Litterman model is explained in detail. The authors provide a complete derivation of the model using the main principles from Bayes' Theorem and the "Mixed Estimation" model by Thiel. They then consider various frameworks of the  model. Several other papers are examined, with examples demonstrating the concepts.

  • Option Traders Use (very) Sophisticated Heuristics, Never the Black-Scholes-Merton Formula (Nassim Taleb)

    In this 2009 paper, Nassim Taleb and Espen Gaarder Haug consider the heuristically-derived pricing formula used by option traders. The authors then examine the work by Black, Scholes and Merton, arguing that the trio (1) "did not invent any formula". Instead they say, the trio simply removed the "risk parameter" to find an argument to make a popular and already ...

  • Bank for International Settlements

    The bond benchmark continues to tip to swaps (BIS, 2017)

    By the 1990s, basis risk had caused bond markets, like money markets before them, to start shifting from the use of government rates as benchmarks to the use of private ones. Developments since the Great Financial Crisis of 2007–09, including derivatives reforms and Libor scandals, had the potential to disrupt this shift. Yet BIS data on derivatives turnover indicate that ...

  • S&P Dow Jones Indices

    Seeking Income: Cash Flow Distribution Analysis of S&P500® Buy-Write Strategies (S&P Dow Jones Indices)

    In recent years, income-seeking market participants have shown increased interest in buy-write strategies that exchange upside potential for upfront option premium. Our empirical study investigated popular buy-write benchmarks, as well as other alternative strategies with varied strike selection, option maturity, and underlying equity instruments, and made the following ...

  • Guggenheim Partners

    The ABCs of ABS (Guggenheim, 2017)

    Asset-backed securities (ABS)—also called securitized products or structured credit—finance pools of familiar asset types, such as auto loans, aircraft leases, credit card receivables, mortgages, and business loans. In one way or another, these asset types represent contractual obligations to pay. The principal job of ABS investors is to determine value by analyzing the cash ...

  • Brexit - What now for the cleared derivatives markets? (FIA, 2016)

    This paper by FIA examines the impact of Brexit on the UK's cleared derivatives markets. The authors comment on the uncertainty likely to be experienced during exit negotiations as well as the framework yet to be created for the UK's future relationship with the EU and other non-EU states.

  • Investment Outlook 2016 - Late-cycle investing (Citibank)

    Today’s late-cycle conditions place even greater importance on appropriate investment selection and risk management This 60 page report from Citibank covers all of the world's major regions, with special features on geopolitics, the business cycle, emerging markets, volatility and healthcare stocks.