Street firms and hedge funds are starting to swap commodity correlation exposures through a relative-value trade termed a commodity correlation swap.
Increasing demand from retail and high-net-worth investors for access to commodities has left derivative desks with a buildup of exposures to correlated moves in commodities. With some firms touching risk limits as a result, commodity correlation swaps have appeared as a way to offload this exposure to hedge funds. Because dealers have sold baskets of commodity options in such big sizes to retail over the last two years, some hedge funds are prepared to take the view commodity correlation is overvalued.
Firms including BNP Paribas, SG Corporate & Investment Banking and JPMorgan have started offering hedge funds the correlation swaps. The trades are in fact based around options. One volatility fund manager in London said he entered a five-year deal, declining to name the counterparty. In the trade, he sold an option on a bespoke basket of commodities that included West Texas intermediate crude oil, natural gas, aluminum and copper. He then bought options on each entity in the basket.
One commodity derivatives trader in London said a lot of prices are being shown but it is hard to tell how many deals have been done. He estimated he has seen maybe two or three in the last month, about USD50 million at a time. This is similar to equivalent deals for equity correlation, he noted.
One Paris-based hybrid derivatives trader noted interested funds so far have been mostly equity or fixed-income funds already familiar with trading correlation in other asset classes. Traditional energy trading funds, however, have not yet got involved and nor have the big energy dealers like Goldman Sachs and Morgan Stanley. He suggested this is because these firms and funds tend to concentrate on big-ticket curve-based trades, rather than complex pay-offs. He predicted the entrance of equity and fixed-income investors will see strategies already popular in other asset classes take root with commodities. "We'll see the same evolution, but faster," he added.
