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Autocallables - a long rant/thread
If there’s any financial product that I think should be un-invented, and any proponents thereof taken to the back of the woodshed, it’s autocallables. I should know, I’m one of the lucky idiots who gets to run a risk warehouse in this dogshit.
So here’s why you should care
(2/n)
So here’s why you should care
(2/n)
Let’s take a step back - what is an autocallable?
It’s THE equity-linked structured note that any bank sells to private banks, HNWIs, even institutions (esp in Europe). Works just like any structured note - bank sells its sub paper to client,strips coupons off, slaps equity
(3/n)
It’s THE equity-linked structured note that any bank sells to private banks, HNWIs, even institutions (esp in Europe). Works just like any structured note - bank sells its sub paper to client,strips coupons off, slaps equity
(3/n)
payoff on top. This particular payoff works as follows(simple case):if at any periodic observation date, the underlying equity (stock/index) is above a certain theshold, it pays a coupon and calls, returning principal. If not, it continues. If at term it hasn’t called/paid (4/n)
Buyer is short a down&in put struck ATM w/ barrier somewhere on the downside, typically 50-70% of initial.
So the bank is long a digital KI, short some ATM digitals, sweet, cheap downside selling it to dummies right? Wrong. What you get is this path dependent POS where (5/n)
So the bank is long a digital KI, short some ATM digitals, sweet, cheap downside selling it to dummies right? Wrong. What you get is this path dependent POS where (5/n)
You are initially long d/s vega, long divs (selling fwds). Most will hedge this by selling some long dated puts. As the market moves, your exposure changes. Market rallies, your note’s duration decreases, exposure to term put &fwd decreases. If you hedged initially, you’re (6/n)
Busy buying back vega and divs. Now if the market pukes a bit, your note duration increases, you’re getting more exposure to the KI, longer vega, shorter fwd. now you’re busy selling vega, selling divs. Now, if the market pukes hard enough, the KI starts to look more like (7/n)
Just a fwd - so you’ll be busy unwinding your hedges: buying back vega at the shittiest imaginable time to be buying vega. So net net what you have is a position that’s short vanna(to a point) short downside skew, and short div convexity.
OK so you’ve described a great (8/n)
OK so you’ve described a great (8/n)
Dynamic in which to lose money hedging. So what?
Well, if you look at the equity options markets in asia and Europe in the last decade, the ZIRP has driven yield-focused investors to load up on variants of this dogshit (and there are enough for a separate thread) to a degree(9/n
Well, if you look at the equity options markets in asia and Europe in the last decade, the ZIRP has driven yield-focused investors to load up on variants of this dogshit (and there are enough for a separate thread) to a degree(9/n
That the long end vol dynamic is entirely dominated by autocall flows. To the point where under more stable circumstances even skews turn to smiles in some indices in the back (with a special kink around “peak autocall vega” to reflect that short skew)
S&P vols in the back (10/n)
S&P vols in the back (10/n)
Still exhibit upward sloping term. But watch this get ground down if the “lower-rates-for-longer” narrative takes hold. Some moron somewhere will surely attribute it to some “fed put printer goes brrr” shit. But it will be the humble autocall flows that will grind that shit (11/n
Down towards flat, simply because of the weight of these flows. And the truly special thing this shitty product brings is a special kind of fragility - you pass that magical “peak” point in dealer vega and all bets are off. We saw it in March-April in Europe and it’s nasty (12/n)
And next time it comes, there won’t be so many aimCo’s holding the bag on capped/uncapped var spreads, corridor var or the like that dealers have been “risk-recycling”
(You’ll see changes in dealer products too, but that genie’s hard to put back in the bottle...)
(You’ll see changes in dealer products too, but that genie’s hard to put back in the bottle...)
