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I only have one worry about the OTC derivative markets: the big wholesale
players have been taking on new positions from their customers since trading
began in these markets. Many/most of the instruments they have on their
books have maturities of at least 1 year and OFTEN 10+ years. As long as
their business increases they get to "book" some new trade (bid-ask) profits
and perhaps release the rest over the life of the trade. But how many of
them can say how much it will really cost them to hedge their longer term
positions? Most delta hedging is done via the futures markets so they are
almost certainly mis-matching the maturity of their delta hedges with their
underlying positions. The constant requirement to roll-over their positions
and adjust their size must be quite a weight of friction on their long term
profits.
I expect for most participants the average age of the positions on their
books is now increasing steadily (at least in some sectors). There must be a
point where these businesses find out whether their theoretical profits will
actually cover the long term cost of hedging.
Any comments?
R
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