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Equity derivatives: Structuring houses go with the flow

Shift from return-seeking to risk management; But more complex products expected to revive

Two trends in equity derivatives were predicted after the heavy losses made by many investment banks last year: a shift from exotics to plain-vanilla products and the transfer of over-the-counter trading to exchanges.

In June, bank analysts at JPMorgan predicted that 2009 equity derivatives revenues would be 29% down on 2008, driven in part by the decline in fees earned on exotic products. Although 2010 revenues are expected to be up about 16% on this year, a tougher regulatory environment might force a permanent shift to lower-margin flow products.

Early evidence suggests that there has already been a move away from complex return-seeking structures towards risk management, particularly by retail investors. "Since the crisis, demand for retail structured products has shifted from complex to simpler payoffs. It is not always possible to reproduce a complex payoff in a vanilla product but some investors are willing to accept the trade-off to get more transparency," says Kevin Woodruff, global head of financial engineering at Morgan Stanley.

More vanilla
A recent survey of European institutions by financial consultancy Greenwich Associates also shows an increase in the use of vanilla options and futures by institutions. For example, the proportion of hedge funds using single-stock options increased from 71% to 95% in the 12 months to June this year.

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