Can Exotic Equities Pay Off for Online Brokers?

 
 
By Theresa Carey  |  Posted 2004-08-24 Print this article Print
 
 
 
 
 
 
 

Opinion: Regulatory changes and technological innovations have made some newly defined derivatives available. But can these products give brokers a bump in their transaction counts?

The name of the game for brokerages is DARTs, or Daily Average Revenue Trades. The object is to increase DARTs month by month, no matter what happens to the market overall. Online brokers strive to keep their numbers up by expanding their core offerings—the ability to trade stocks, options, mutual funds and bonds—with additional research and services. Consumers are most familiar with the same products that were traded under the Buttonwood tree on Wall Street at the end of the 18th century—stocks and bonds. Options trading dates back to at least the 17th century and the Dutch tulip markets, but options did not become a mainstream product until the mid-1970s. Technology made alternative investment vehicles accessible to the retail consumer in the waning years of the 20th century. The evolution of the derivatives and commodities markets, and the exchanges devoted to the trading of these products, all came together to make new types of equities available via online brokers.
Today, the types of equities and derivatives are diverse and plenty, and retail consumers can easily access many of these products online, lowering the barriers to entry for investors. Newly defined equities have been introduced to keep DARTs growing, but they dont seem to be popular—yet—with the trading public.
SSFs (single stock futures) were rolled out to the marketplace in the fourth quarter of 2002. An SSF is a contract to deliver the underlying asset, in this case the underlying equity, on the delivery date specified by the contract. Each contract is worth 100 shares of the underlying stock. A $1 change in price of the underlying stock equates to $100 for the futures contract. Unlike options, which have an asymmetrical payout algorithm, the payout in futures is symmetric. The buyer of an option can lose, at most, the amount of the premium paid, but the upside is much larger. The seller of an option can make, at most, the amount of a premium, but can lose much more depending on the change in the underlying stock price. With a futures contract, you can lose as much as you can gain. The fact that no security is actually purchased at the time of the transaction results in some of the technical challenges of SSFs pertaining to cost basis, buying power, margin and other aspects of the product. In effect, the holder of the contract has only a profit or a loss. Although it had been proposed decades earlier, the SSF had been banned by the regulatory bodies for more than 20 years since it was a combination of a future and a security, making it difficult to regulate. The outdated trade-through rule must die, Theresa Carey writes. Click here to read more. Another new equity is the FRO (Fixed Return Option). FROs have existed in the OTC (over-the-counter) market for some time, where they are known as binary or "all-or-nothing" options. As the name suggests, a binary option either pays or it doesnt, and the payout is fixed or discontinuous. As an OTC product without any exchange backing, the binary option has been employed only by institutional customers. With FROs, however, the Amex seeks to bring the product into the mainstream with exchange listing and liquidity providers. Like the "put" and "call" of its cousin, the traditional option, there are two primary components of the FRO, "finish high" and "finish low." A contract returns $100 if the underlying security finishes high, closing above the strike price at expiration, or if it finishes low, closing below the strike price. A closing price "at the money," that is, at the established strike price, pays the buyer nothing, and the proceeds go to the seller. A mutual fund company recently fought back against phishing attacks. Click here to read more. Plans for the initial roll-out of FROs propose that 30 underlying securities will receive FRO listings. These underlying securities will comprise 20 equities, five ETFs (exchange-traded funds) and five indexes. The objective of the initial listing is to select the listings pursuant to existing criteria set forth in Rules 915 and 916 governing initial listing requirements and continuous listing requirements, respectively, for exchange-traded options. The stocks that will most likely inspire FROs are among the most heavily traded. On the Nasdaq, expect to see FROs for Microsoft, Intel, Cisco, Dell, Amgen, Comcast and Oracle. On the NYSE, youll see General Electric, Exxon, Pfizer, Citigroup, Wal-Mart and American International Group. Innovation can create complexity. While some vendors have chosen to back away from support of the SSF as a result of the technological challenges and absence of immediate retail-customer demand, others have moved forward to create access for the retail consumer in the hope that the unique offering will pump up their DARTs. Next Page: Changing the average investors perception of risk.



 
 
 
 
Theresa is the Editor of CIOInsight.com's Finance Industry Center. She's been writing about financial technology issues since 1990 for a wide variety of publications, including PC Magazine, Newsweek, Fortune, and Fortune Small Business. She is also a Contributing Editor to Barron's and writes their 'Electronic Investor' column.

Theresa received a B.A. from the University of California, Berkeley, and a M.S. from the University of Santa Clara. She also has a private pilot's license. When she's not at her computer, she coaches a local high school volleyball team, plays softball and volleyball, and takes part in many Cal Alumni Band events. She lives in Northern California.

 
 
 
 
 
 
 

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