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Equity Arb Index Structure Prepped

Merrill Lynch in the U.S. is preparing to offer investments linked to an equity volatility arbitrage index it launched last week.

Merrill Lynch in the U.S. is preparing to offer investments linked to an equity volatility arbitrage index it launched last week. The index is similar to structures offered by Dresdner Kleinwort (DW, 6/2) and more recently ABN AMRO (DW, 12/15). These mimic a popular hedge fund equity arbitrage strategy by selling implied volatility through variance swaps to receive the--usually positive--difference between option-implied volatility and realized volatility.

Heiko Ebens, equity-linked analyst at Merrill in New York, said the firm expects to see interest in capital-protected structures linked to the index. He declined to give details of anything the firm is working on, but noted it would be possible to write the same structures on the equity arbitrage index as the firm offers on the Standard & Poor's 500, for example. "Ultimately our goal here is to essentially try to do what [exchange-traded funds] have done," he said, noting the index will make a hedge fund strategy accessible for a wider range of investors. "We believe a lot of these things can be done on a passive basis."

The Merrill index references an investment strategy that sells rolling three-month variance swaps on the S&P 500. Ebens declined to give notional sizes of contracts but said capacity is not a problem and the index could potentially support several billion U.S. dollars.

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