Firms including Deutsche Bank and Goldman Sachs have started offering equity outperformance options with a conditional feature to the payout. Outperformance options, in which for example an investor pays a premium to receive the performance of one equity index over another, have been one of the big hits this year.
The tweak allows investors to take more specific views. For example, investors receive the outperformance of an index above a certain barrier, or for the days it stays within a certain range. Popular outperformance options have been long Nikkei versus other major equity indices, and more recently on baskets of large-cap stocks versus mid-cap stocks. The conditional versions of the same trade have mirrored these, with maturities typically under a year.
Tim Hart, head of equity derivatives sales for Europe at Deutsche Bank, explained the instruments are a continuation of the growing business in outperformance options. The firm did its first trade in the second quarter, he added.
While Deutsche Bank was the first to trade such a deal with a client, other firms with big hedge fund client bases and exotic equity trading desks are hot on its heels. Goldman Sachs has shown some prices, but it could not be determined if it has traded any of the options with clients. Interdealer brokers, however, said they had not yet seen any of the instruments.
One trader who has seen a term sheet for the options questioned whether there are enough equity investors out there with such specific views. "Who has such a strong view on anything these days?" he asked. He also noted, while the conditional feature has brought down the option premium, "There's a lot of cheap stuff right now."
A salesman at a firm offering the instruments explained that while the conditional feature is a natural evolution of the option, rising skew and volatility caused by tanking equity markets in the last few months helped precipitate the innovation.
