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Capital Markets

Equity derivatives: Investors swap stocks for derivatives

Greater anonymity, leverage and lower trading costs are seen as incentives.

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Equity derivatives are increasingly being used as a substitute for actual shares in North America, according to a recent report by Greenwich Associates.

The study of the equity derivatives market, released in November, shows that a growing proportion of investors are experimenting with equity derivative “flow” products, such as listed single-stock and index options, vanilla OTC single stock and index options, and equity swaps, as a means of gaining exposure and taking positions and as a way to minimize trading costs.

The use of index futures, exchange traded funds, single-stock futures and equity swaps is also increasing.

Proportions

The proportion of institutions using single-stock options has risen from 68% in 2003 to 76% this year. During the same period, the use of index options rose from 59% to 63%. The use of index futures has risen from 55% to 58%, and the proportion using exchange traded funds has now reached two-thirds, up from 57%.

Investors are turning to derivatives because they offer greater anonymity, leverage and tax advantages.

“The rising employment of equity derivatives in such strategies as actively managed long-only equity, passive equity index and simple price speculation, suggests that a rising number of institutions are using equity derivative instruments as substitutes for cash equity trading,” says Greenwich Associates consultant John Colon.

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