Equity correlation swaps, which have been dismissed by some as an investment bank gimmick for disposing of their own correlation risk, are becoming established as a product in their own right, according to broker GFI Group. Banks have correlation exposure from structured products they have sold based on a basket of equity options and an increasing number of hedge funds and bank prop desks are now looking to buy correlation exposure.
Correlation trades are already popular in the credit markets, noted Ian Clague, global head of exotic credit derivatives in New York. Correlation swaps could be a cross-over product similar to equity-default swaps, he added. "Many people are trying to draw parallels between the equity and the credit world," he said. GFI Group is trading realized correlation swaps, according to Clague. The trade in its broadest form is essentially an evolution of a dispersion trade using variance swaps. It enables a counterparty to take a punt on the correlation change between a basket of around 10 stocks and its index, usually for a three-year maturity. Correlation trades are already popular in the credit markets and Clague believes the equity correlation potential is undervalued.
