Dual Directional Structured Products
By: Geng Deng, Tim Dulaney, Tim Husson, and Craig McCann (Jan 2013)
Published in the Journal of Derivatives & Hedge Funds, (5 June 2014).
We analyze and value dual directional structured products - or simply dual directionals
(DDs) - which have been issued in large amounts since the beginning of 2012. DD's evolved
out of another type of structured product called absolute return barrier notes (ARBNs);
however, DD's lack principal protection and have different embedded options positions, which
have yet to be described in the literature. We find that DDs can be broadly organized into
two categories: single observation dual directionals (SODDs) and knock-out dual directionals
(KODDs). We determine the appropriate option decomposition for these categories and
provide analytical formulas for their valuation. We confirm our analytic results using Monte
Carlo simulation and use both techniques to value a large sample of DDs registered with the
Securities and Exchange Commission up to December 2012. Our results indicate that like
many types of structured products, DDs tend to be priced at a significant premium to present
value across issuers and underlying securities and that the present value of the decomposition
is smaller than the face value net of commissions. We find that DDs with embedded leverage
or a single observation feature tend to be worth less than products either without leverage
or with a knock-out option.
Isolating the Effect of Day-Count Conventions
By: Geng Deng, Tim Dulaney, Tim Husson, and Craig McCann (May 2012)
Day-count conventions are a ubiquitous but often overlooked aspect of interest-bearing investments. While many market traded securities have adopted fixed or standard conventions, over-the-counter agreements such as interest rate swaps can and do use a wide variety of conventions, and many investors may not be aware of the effects of this choice on their future cash flows. Here, we show that the choice of day-count convention can have a surprisingly large effect on the market value of swap agreements. We highlight the importance of matching day-count conventions on obligations and accompanying swap agreements, and demonstrate various factors which influence the magnitude of day-count convention effects. As interest rate swaps are very common amongst municipal and other institutional investors, we urge investors to thoroughly understand these and other `fine print' terms in any potential agreements. In particular, we highlight the ability of financial intermediaries to effectively increase their fees substantially through their choice of day-count conventions.
Optimizing Portfolio Liquidation Under Risk-Based Margin Requirements
By: Geng Deng, Tim Dulaney, and Craig McCann (Apr 2012)
Published in the Journal of Finance and Investment Analysis, 2(1): 121-153, 2013.
This paper addresses a situation wherein a retail investor must liquidate positions in her portfolio -- consisting of assets and European options on those assets -- to meet a margin call and wishes to do so with the least disruption to her portfolio. We address the problem by first generalizing the usual risk-based haircuts methodology of determining the portfolio margin requirement given the current positions of a portfolio. We derive first and second-order analytic estimates for the margin requirements given the positions. Given this generalization, we determine the liquidation strategy that minimizes the total positions liquidated and meets the margin requirement. We implement the strategy on example portfolios and show advantages over traditional piece-wise liquidation approaches. The analytic approach outlined here is more general than the margin context discussed. Our approach is applicable whenever an investor is attempting to maximize the impact of their capital subject to leverage limits and so has obviously applications to the hedge fund industry.
