Ben Waters, trader, is a portfolio manager who oversees investment of outside capital in addition to his own portfolio. With extensive experience in options and equity trading, Benjamin Waters, trader, also has a proven track record in Delta One trading. This article will take a closer look at Delta One trading, exploring how Delta One products differ from other financial products like options.
Delta One products are derivatives with a linear payoff profile that is symmetrical with the underlining asset. A Delta One product exposes the investor to the same risks, and potential rewards, as they would attract if they owned the underlying asset. Whereas an option has an asymmetric payoff, with price changes in the derivative differing from the underlying asset, a Delta One product precisely replicates the underlying asset’s position in the index.
Delta One products take their name from the term ‘delta’, which is used in the trading of derivatives, and options in particular, to measure their sensitivity to changes in the underlying asset. The delta of a financial instrument is defined mathematically as the first-order derivative of the instrument’s value relative to the price of the underlying asset. Delta One products are financial instruments that have a delta of one, meaning they have a symmetrical and linear payoff profile with their underlying assets. Common examples of Delta One products include futures, forwards, exchange-traded funds (ETFs) and equity swaps. Since the price of these financial products closely tracks the price of their underlying assets, their delta is close to one.
Large investment banks operate Delta One trading desks as part of their equity derivatives departments. The attraction of Delta One trading desks lies in their flexibility and potential to create a unique revenue stream for the bank. Delta One products do not have optionality, although they can be built from options using parity between calls and puts. Delta One trading desks typically generate the majority of their revenues from arbitrage strategies linked to various Delta One products, along with associated activities such as stock index arbitrage processed on different trading platforms or dividend arbitrage between different products.
Delta One traders and desks implement various strategies, which are often a tightly guarded secret. The best Delta One traders have the ability to blend creative hedging, successful market timing and institutional access to funding and flow to produce a unique, multi-source return for the bank. For Delta One traders, the direction of individual stocks or the overall market can be entirely irrelevant.
Delta One trading desks generate revenue by employing a variety of specialist strategies related to various Delta One products and related activities, such as equity index arbitrage, equity financing and dividend trading. Described by FT Alphaville as ‘one of the hottest areas of banking’, Delta One trading has been hailed as the last domain of proprietary trading in the banking industry, paving the way for traders to get away with taking risks through their market-making activities. Meanwhile, the Financial Times describes Delta One trading desks as ‘the special forces of trading.’
A Delta One product is essentially a derivative that has a virtually one-to-one relationship with its underlying asset in terms of price movements. When the value of the underlying product fluctuates, the Delta One product moves in sync, shifting in the same direction with a similar magnitude. For every instantaneous move in the price of the underlying asset, Delta One products move in tandem. Delta One products are sometimes synthetically created by combining different options and may incorporate a range of different underlying securities, thereby presenting the holder with an easy and effective means of gaining exposure to a tranche of different securities with a single product.