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Citi Considers “Old School” Hedge Options, Likes HY Swap

Citi analysts Stephen Antczak and Jung Lee have been fielding an unusually large number of hedging questions recently, as a Fed rate hike looms, a Greek tragedy could emerge again as new elections are called and the stock market over the past few days has exhibited weakness.

The search for the best "hedge" finds a swap product

The pair searches for the illusive “best” hedging method for “an old school high-yield portfolio manager that is willing to spend a certain amount on a hedge.” This sentence shows an approach taken to hedging: it can be a cost. Professional investors often evaluate hedging options based on such cost, and in this regard the report wonders “where to spend” the hedging insurance budget. Their conclusion is a product for hedging is the high yield credit total return swap, one typically marketed by large banks by now also centrally cleared in certain circumstances.

While the research addresses the "budget" in the top of the research piece, oddly the actual cost of the swap hedge, perhaps among the most interesting of the hedging options, was not detailed to a significant degree in the analysis.

Cost, of course, can be considered from the standpoint of many subcategories make up the whole. There is the cost of execution, an ongoing “insurance premium” to pay in certain swap products much like there is option premium time decay. Other costs often include the performance drag when a market moves against a hedge, which is where the report started its consideration along with the potential hedging tools.

Citi mostly considers products commonly sold by big banks

The first consideration in this analysis is perhaps also the most frustrating. In evaluating “options” the Citi analysis excludes what in some cases are the most cost effective options. “…we explore hedging from the vantage point of an old-school PM running a small ($100 mm) high-yield fund. When bearish he normally trims his risk exposure by holding more cash, but he is now considering a few macro level alternatives,” Antczak and Lee write, then create a larger rather wide wall keeping out financial innovation. “Importantly, each alternative is plain vanilla — no options, no credit curve...


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