Equity derivative trades on rise

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Investors are increasingly using sophisticated equity derivative trades to bet on the stronger performance of large multinationals against their smaller rivals in the wake of the credit squeeze.

Large companies have outperformed small- and medium-sized companies on the equity markets since August as they are seen as a safer investment in times of uncertainty because of their stronger cash flows, solid growth and brand recognition.

For example, in the UK the FTSE 100 has outperformed its midcap sister the FTSE 250 by about 10 per cent since the start of August. The FTSE 100 has traded up by 3.1 per cent since then compared with the FTSE 250, which has fallen by 6.3 per cent.

By using equity derivatives options, investors can take a view on where an index will be in, say, six months’ time, potentially allowing them to profit in the event of bigger-cap indices outperforming the smal­ler exchanges.

David Moroney, head of equity derivatives structured assets at Barclays Capital, said: “Investors are realising they can make money from betting on the comparison of performance between different markets, rather than taking a directional trade.

“This sophistication of investors has helped the equity derivatives market grow dramatically. We are seeing many investors using these relative value trades in the US and Europe,” he added.

“Asian investors are also using them as their economies grow and they become more sophisticated.”

Mr Moroney said bigger companies started to outperform around March and April as investors became increasingly nervous about the problems in the US housing market. This trend increased in July and Aug­ust as the crisis deepened.

Shaun Wainstein, head of equities and derivatives for BNP Paribas in London, added: “We have developed equity derivatives products based on the idea that large companies will outperform smaller companies.

“In fact, we created a very successful product for Italian retail investors that gave the retail clients a simple way to invest in this strategy. Logically, the credit crisis does help this trade. On average, larger companies will outperform smaller ones in times of uncertainty.”

Nino Kjellman, head of equity derivatives trading at Deutsche Bank, agreed that this had been a popular trade in recent months.

According to Barclays Capital, globally big companies listed on the main exchanges have outperformed small- and medium-sized companies on the junior exchanges by 6.5 per cent this year.

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