Why don't OMMs trade Exotics?
This is a random question from a friend, but why don't OMMs trade exotic options? One of my reasons was due to the balance sheet and complex hedging of longer-duration products that OMMs don't want to have any residual second-order exposure to.
Do those reasons sound correct? His rebuttal was some OMMs have some deep pockets, but I still think that the type of user of an exotic/structured product is going to a bank due to the cross-selling, speciality/white-glove service, etc.
Would another reason be not enough edge in these products? From my knowledge some of the longer-term structured product hedging gets complex enough where these teams just can't be let go by banks and they keep a couple people on to manage the hedging flow from what someone told me in APAC where these products are much more common.
I've never traded exotics, but was curious about this myself as well.
Ever heard of a little thing that’s important to OMMs called liquidity? The kind of OMMs you are thinking of stick to exchange traded products.
Hahaha thank you for the condescending reply. I’m familiar with screen trading. Have you heard about the OTC markets or ever wondered what “Institutional Trader” at Optiver or the Quantitative Trader on the “Block Equities” desk is doing at CitSec or SIG?
FYI, Optiver, CitSec, SIG, IMC, DRW all have institutional trading desks quoting size in OTC traded markets.
Read the articles on CitSec and Jane Street breaking into the fixed income markets. Regardless of the percentage of revenue that comes from these desks, the fact they have strong OTC businesses in these products is why I am asking why do they not trade exotics.
Haha ok fair enough it was condescending, but not entirely wrong. I stand by liquidity as a main reason but another is volumes. I work in fixed income derivatives and almost everything I do is OTC. You can go on the SDR and see how many exotics trades there are in a day…not many. Not to mention most exotics users in my space are companies that see actual use cases for them based on their operations. As you are probably aware, to trade these products in the U.S. you need an ISDA, KYC etc., so not a cheap thing to onboard a client. Banks will do it because they are making money off of other business with the client as well probably, but from a market maker/prop shops perspective I don’t see how this makes sense (could be wrong just don’t see it being profitable). You are right we see Citadel popping up more in our space, but mostly on SEF (cleared swaps), which only the most sophisticated users trade on (interbank, some F500 etc.). They are making markets here because it is the most liquid and highest volume transaction space, with limited counterparties to sign ISDAs with. I don’t know anything about equities but I would be surprised if it was different.
“OTC” is a bit of a misnomer for the names you mention. They aren’t trading in opaque OTC markets as swap dealers through bilateral credit lines like banks. OTC in the context of HFT/Prop MMs means privately negotiated block trades or other methods of privately negotiated trading. But once a deal is struck, it’s posted to the relevant exchange. So that’s why exotics & structured products doesn’t exist as a business line for these names.
I wouldn't be shocked if eventually some prop trading firms started trading exotics as in the past few years some of the larger trading firms have become very well capitalized and increasingly competing with banks in less liquid markets. Most prop trading firms were originally focused on US/Europe lit markets with relatively modest amounts of capital and even though they have branched out and are better capitalized now Asian structured products/exotics is probably not the most lucrative market for them as they don't have much if any customer flow in these products. Most of these firms only have a few thousand employees globally (and probably only a few hundred in Asia) so they need to be strategic on what areas to focus on while banks have a lot more headcount to trade a wider array of different products.
Not an expert but I think execution is more manual for exotics and typically you to talk to a human at a bank, whereas most quant market makers like more automated stuff.
Institutional Desks operate at most of the “quant market makers” you’re referring to. Even IMC heavily focused on speed and low latency screen quoting has an institutional broker desk. SIG and CitSec have block equities desks where QTs sit as well.
Yeah but wasn't the question why OMMs don't really trade exotics as much? My point is that they trade these products a bit less. I agree with what you're saying, but having worked at one of these places I think by headcount the phenomenon you're referring to is like <2-3% of the firm.
Partially accurate: this applies well to D1 products & cash equities. But non linear derivs are still negotiated the old fashioned way (voice / BBG chat)
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