Delta One
Encyclopedia
Delta One products are a class of financial derivative that have no optionality
and as such have a delta of (or very close to) one - that is to say that for a given percentage move in the price of the underlying asset there will be a near identical move in the price of the derivative. Delta one products often incorporate a number of underlying securities and as such give the holder an easy way to gain exposure to a basket of securities in a single product. Examples include equity swaps, forwards
, futures
and ETF
s.
to changes in the price of the underlying asset. The delta (Δ) of an instrument is the first mathematical derivative
of the option value with respect to the underlier's price.
, symmetric payoff
profile. That is, not an option or a product with embedded options.
Examples of delta one products are Exchange-traded fund
s, equity swap
s, custom baskets, linear certificates, futures, forwards
, trackers, and Forward rate agreement
s.
As the price for these products closely track their underlying asset and risk free rate, their delta will be close to 1.
finance or equity derivatives divisions of most major investment banks
. They generate most revenue through a variety of strategies related to the various delta one products as well as related activities, such as dividend trading, equity financing and equity index arbitrage
. In theory such desks should be relatively low risk areas for the banks as the products are generally hedged
. FT Alphaville
has described Delta One trading as "one of the hottest areas in banking" and "...the last domain of prop trading
in the banking sector, where via market-making
activities, traders can still get away with taking ample risks."
Two high profile cases of losses resulting from rogue trading
(those of Jérôme Kerviel
at Société Générale
and Kweku Adoboli at UBS) involved Delta One traders.
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
and as such have a delta of (or very close to) one - that is to say that for a given percentage move in the price of the underlying asset there will be a near identical move in the price of the derivative. Delta one products often incorporate a number of underlying securities and as such give the holder an easy way to gain exposure to a basket of securities in a single product. Examples include equity swaps, forwards
Forward contract
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a...
, futures
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...
and ETF
Exchange-traded fund
An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...
s.
Delta
For a derivative, the delta measures the sensitivitySensitivity
Stimulus|Sensitivity may refer to:* Sensitivity , the ability to react to a stimulus* Sensitivity , the strength of physical or emotional reaction in people* Sensitivity , variations in process dynamics and control systems...
to changes in the price of the underlying asset. The delta (Δ) of an instrument is the first mathematical derivative
Derivative
In calculus, a branch of mathematics, the derivative is a measure of how a function changes as its input changes. Loosely speaking, a derivative can be thought of as how much one quantity is changing in response to changes in some other quantity; for example, the derivative of the position of a...
of the option value with respect to the underlier's price.
Types of products
It is a derivative with a linearLinear
In mathematics, a linear map or function f is a function which satisfies the following two properties:* Additivity : f = f + f...
, symmetric payoff
Payoff
Payoff may refer to:* Bribery* A payoff dominant equilibrium in game theory* Payoff matrix or payoff function in a normal form game in game theory* Payoff set in set theory* Payoff, a 1991 TV film starring Keith Carradine...
profile. That is, not an option or a product with embedded options.
Examples of delta one products are Exchange-traded fund
Exchange-traded fund
An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...
s, equity swap
Equity swap
An equity swap is a financial derivative contract where a set of future cash flows are agreed to be exchanged between two counterparties at set dates in the future. The two cash flows are usually referred to as "legs" of the swap; one of these "legs" is usually pegged to a floating rate such as...
s, custom baskets, linear certificates, futures, forwards
Forward contract
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a...
, trackers, and Forward rate agreement
Forward rate agreement
In finance, a forward rate agreement is a forward contract, an over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used...
s.
As the price for these products closely track their underlying asset and risk free rate, their delta will be close to 1.
Trading desks
Delta One trading desks are either part of the equityEquity (finance)
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
finance or equity derivatives divisions of most major investment banks
Investment banking
An investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities...
. They generate most revenue through a variety of strategies related to the various delta one products as well as related activities, such as dividend trading, equity financing and equity index arbitrage
Index arbitrage
Index arbitrage is a subset of statistical arbitrage focusing on index components.The idea is that an index is made up of several components that influence the index price in a different manner.For instance, there are leaders...
. In theory such desks should be relatively low risk areas for the banks as the products are generally hedged
Hedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...
. FT Alphaville
FT Alphaville
FT Alphaville is a daily news and commentary service for financial market professionals created by the Financial Times in October 2006. The service includes an email-based morning financial brief, a blog, and two message boards, one called "Markets Live" and another, added two years after its...
has described Delta One trading as "one of the hottest areas in banking" and "...the last domain of prop trading
Proprietary trading
Proprietary trading occurs when a firm trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments, with the firm's own money as opposed to its customers' money, so as to make a profit for itself...
in the banking sector, where via market-making
Market maker
A market maker is a company, or an individual, that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid-offer spread, or turn. From a market microstructure theory standpoint, market makers are net sellers of an option to be...
activities, traders can still get away with taking ample risks."
Two high profile cases of losses resulting from rogue trading
Rogue trader
A rogue trader is an authorised employee making unauthorised trades on behalf of their employer. It is most often applicable to financial trading, and as such is a term used to describe persons - professional traders - making unapproved financial transactions....
(those of Jérôme Kerviel
Jérôme Kerviel
Jérôme Kerviel is a French trader who has a pending appeal of his conviction in the January 2008 Société Générale trading loss incident for breach of trust, forgery and unauthorized use of the bank's computers, resulting in losses valued at €4.9 billion.Société Générale characterizes Kerviel...
at Société Générale
Société Générale
Société Générale S.A. is a large European Bank and a major Financial Services company that has a substantial global presence. Its registered office is on Boulevard Haussmann in the 9th arrondissement of Paris, while its head office is in the Tours Société Générale in the business district of La...
and Kweku Adoboli at UBS) involved Delta One traders.