Commodity Hybrids Trading

James Groves, Barclays Capital

What is hybrids trading?

Multi-asset commodity payoffs

Who wants to trade these?
Customer base
Investors (retail, institutional)
Hedge Funds
Corporates

Growth of hybrid derivatives

10,000,000,000

9,000,000,000

8,000,000,000

7,000,000,000

6,000,000,000

Client cum
Broker cum
5,000,000,000

4,000,000,000

3,000,000,000

2,000,000,000

1,000,000,000

12-2006
11-2006
10-2006
9-2006
8-2006
7-2006
6-2006
5-2006
4-2006
3-2006
2-2006
1-2006
12-2005
11-2005
10-2005
9-2005
8-2005
7-2005
6-2005
5-2005
4-2005
3-2005
2-2005
1-2005
12-2004
11-2004
10-2004
9-2004
8-2004
7-2004
6-2004
5-2004
4-2004
3-2004
2-2004
1-2004
12-2003

Broker market analysis

Commod
NI
CU
ZN
AL
NG
AIG
WTI
AG
XAU
PB
EN
CL
XAG
BR
IM
GSCI
PM
LV

Average Weight
17.07%
16.50%
13.47%
12.56%
8.09%
7.26%
6.91%
5.39%
3.75%
3.51%
1.04%
1.04%
0.78%
0.78%
0.62%
0.41%
0.21%
0.21%

Barclays

Goldman

Deutsche

AIG

Citibank

ABN

JPM

ML

CIBC

10

Soc Gen

11

MPS Finace

12

Calyon

13

BNP

14

UBS

15

Morgan Stanley

Characteristics of Commodities: 1
Tenor and liquidity
Monthly
Metal

Daily
Lots

USD

Lots

USD

LME Clearing Months

Cu

73,127

13,645,630,552

3,656

682,281,528

60

Al

211,639

13,639,890,561

10,582

681,994,528

60

Ni

34,963

5,398,571,488

1,748

269,928,574

27

Pt

1,022,354

2,907,399,902

51,118

145,369,995

Zn

57,730

816,199,308

2,887

40,809,965

Pd

1,041,060

720,472,417

52,053

36,023,621

Pb

24,578

302,578,591

1,229

15,128,930

Ag

18,826,925

232,158,373

941,346

11,607,919

Sn

4,223

177,474,415

211

8,873,721

27

15

15

Tenor and liquidity Constraints

Investor notes
Investor pays 100% (par) at issue date
Investor rcvs 100% at redemption date (T)
Investor owns P% of atm call at T
PV to issuer = Notional(1 df P.C(T))
Solve for P = (1 df ) / C
Using df = 1 / (1 + rT) and Taylor Series => Numerator ~ rT
C(T) vol.T^0.5 => Demoninator ~ vol.T^0.5
Participation ~ (r/vol) T^0.5
Participation grows with the square of time and inverse of vol
Backwardation of forward and vol structure => High participation!

Characteristics of Commodities: 2
Rotation of Ali forwards 2006
2900

2700

2500

2300

2700-2900
2500-2700

2100

2300-2500
2100-2300
1900-2100

1900

1700-1900
1500-1700

1700

1500

Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Jan2006

Feb2006

Mar2006

Apr2006

JulJun2006
May2006
2006

DecNov2006
Oct2006
Sep2006
Aug2006
2006

Characteristics of Commodities: 2
Also Nickel
36500

31500

26500

21500

16500

11500

6500

1500

Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Jan2006

Feb2006

DecNov2006
Oct2006
Sep2006
Aug2006
Jul2006
Jun2006
May2006
Apr2006
Mar2006
2006

31500-36500
26500-31500
21500-26500
16500-21500
11500-16500
6500-11500
1500-6500

Characteristics of Commodities: 2
And recently Copper
8500

7500

6500

5500
7500-8500
6500-7500
5500-6500
4500-5500
3500-4500
2500-3500
1500-2500

4500

3500

2500

Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11

1500
Jan2006

Feb2006

Mar2006

Apr2006

May2006

Jun2006

Jul2006

Aug2006

Sep2006

Oct2006

Nov2006

Dec2006

Characteristics of Commodities: 3
Serial Vol for commodities eg NGF7

45.00%
90,000.00

40.00%
Vol
OI
80,000.00

70,000.00

35.00%

60,000.00

30.00%

50,000.00

25.00%

40,000.00

20.00%

30,000.00

15.00%

20,000.00

10.00%

10,000.00

5.00%

0.00

0.00%
29/12/2006
30/11/2006
01/11/2006
04/10/2006
06/09/2006
08/08/2006
11/07/2006
12/06/2006
12/05/2006
13/04/2006
16/03/2006
15/02/2006
18/01/2006
16/12/2005
16/11/2005
19/10/2005
21/09/2005
23/08/2005
26/07/2005
27/06/2005
27/05/2005
29/04/2005
01/04/2005
03/03/2005
02/02/2005
04/01/2005
03/12/2004

Case Study 1: Forward Start option

Trade Date

05 March 2007

The closing settlement price per barrel of Brent

Strike Date

05 April 2007

blend crude oil on the IPE of the futures contract in

Issue Date

14 April 2007

respect of the first nearby month, stated in U.S.

Valuation Date 05 April 2012

Commodity

W(i)

Commodity Reference Price P(i)

Brent Crude

1/4

dollars, as made public by the IPE

2

Aluminium

1/4

The official settlement price per tonne of high grade

Maturity Date

12 April 2012

primary aluminium on the LME for cash delivery,

stated in U.S. dollars, as determined by the LME
3

Nickel

1/4

The official settlement price per tonne of Primary

Nickel on the LME for cash delivery, stated in U.S.
dollars, as determined by the LME

Zinc

1/4

The official settlement price per tonne of Special

High Grade Zinc on the LME for cash delivery,
stated in U.S. dollars, as determined by the LME

On the Maturity Date, the Issuer shall pay to the Note holder in respect of each Note an amount determined as follows:
Redemption = Notional [ 100% +

MAX (0; Basket final 1)

BasketFinal = W(i ) (i ) Final

i=1
P(i ) Initial
4

where

P(i ) Final = the Commodity Reference Price P(i) of the Commodity (i) on the Valuation Date
P(i ) Initial = the Commodity Reference Price P(i) of the Commodity (i) on the Strike Date, being in respect of each
Commodity:

Case Study 1: Hedging Forward Start risk

=+
Scenario

E[Call]

Delta

1%

10%

5%
10%

A
B
C

20%

E[Fwd
Start ]

5.33%

40%

100
95
90
85
80

Forward Start Risk depends on:

Length of Forward Start
Volatility of Underlying
Correlation between front and back
Convexity of the Derivative

C
F

115

105

120

110

C
K

75
70
65
60
55
1

Example: NG forward start starting Oct, Striking Dec

QNGc1, Last Trade, Bar
11/05/2005 6.691 6.750 6.600 6.725
QNGc1, Close(Last Trade), MA 14
11/05/2005 6.771

Price
USD
BTU

10

12.6
9

12.3
12

11.7
11.4

11.1
10.8

10.5
10.2

9.9
9.6

9.3
9

15 April 2017

20 April 2016

26 April 2015

01 May 2014

06 May 2013

11 May 2012

17 May 2011

22 May 2010

27 May 2009

01 June 2008

07 June 2007

12 June 2006

17 June 2005

22 June 2004

28 June 2003

8.7
8.4
8.1
7.8
7.5
7.2
6.9
6.6
6.3
6
5.7
5.4
5.1
4.8
4.5
4.2
3.9
3.6
3.3
3
2.7

Dec Jan
2002

Feb

Mar

Apr

May

Jun

Jul
2003

Aug

Sep

Oct

Nov

Dec

Jan

Feb

Mar

Apr

May

Jun

Jul
Aug
2004

Sep

Oct

Nov

Dec

Jan

Feb

Mar
Apr
2005

May

Case Study 2: Quanto options

Example of fx hybrid
Option Payoff = EUR_Notional * max [F/K -1,0] where F is USD asset
=> Variable notional option on s
1 2 T
Analytic Solution by quantoing the forward
1. Correlation sensitivity proportional to delta of the option

F ' = Fe

C C F '
= 1 2TFe1 2T
=
F '

2. Commodity delta equal to product of usual delta and correlation adjustment

C C F '
= e 1 2 T
=
F F ' F

Historic Correlation: DJAIG and EUR

Monthly observations
Historic Data sample: 1 year

0.8

0.6

0.4

250
5.8%
7.5%
14.6%
23.0%
27.9%
37.0%
38.3%
49.6%
50.8%
53.1%
59.2%

500
6.6%
6.9%
8.7%
15.4%
22.1%
25.8%
26.7%
37.0%
37.1%
37.3%
38.2%

750
6.7%
6.8%
7.3%
8.9%
15.1%
19.4%
21.3%
25.8%
25.8%
25.9%
26.7%

0.2

0
Dec-07
Jun-07
Dec-06
Jun-06
Dec-05
Jun-05
Dec-04
Jun-04
Dec-03
Jun-03
Dec-02
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
Jan-00
Jul-99
Jan-99
Jul-98
Jan-98
Jul-97
Jan-97
Aug-96
Feb-96
Aug-95
Feb-95
Aug-94
Feb-94
Aug-93
Feb-93
Aug-92
Feb-92

Percentiles
0
10%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%

-0.2

-0.4

-0.6

-0.8

Case study 3: Autocalls

Underlying Size
Exp
CP
GSENER 10,000,000 06-May-08 P

Exp
K
06-May-08

100

100%if Index(min) >Index(initial) * KI

Redemption:
(subject to early redemption)

Index( final)
capped at 100%otherwise
Index(initial)

KI

55%

Early Redemption:

If on Observation Date(i), Index(i) >90%* Index(initial), the note redeems at the

Underlying Size
Exp
CP
GSENER 10,000,000 06-May-08 P

Exp
K
06-May-08

Underlying Size
Exp
CP
GSENER 10,000,000 06-May-08 P

Exp
K
06-May-08

Early Redemption Amount(i) on the Early Redemption Date(i)

Underlying Size
Exp
CP
GSENER 10,000,000 06-May-08 P

Exp
K
06-May-08

Index(i): the fixing of the index on Observation Date(i)

Observation Date(i): see table below
Early Redemption Date(i): see table below

Underlying Size
Exp
CP
GSENER 10,000,000 06-May-08 P

Exp
K
06-May-08

Observation Date

Early Redemption Date

EarlyRedemption
Amount

07/11/05

14/11/05

103.25%

08/05/06

15/05/06

106.50%

06/11/06

13/11/06

109.75%

07/05/07

14/05/07

113.00%

06/11/07

13/11/07

116.25%

06/05/07

27/05/08

119.50%

Underlying Size
Exp
CP
GSENER 10,000,000 06-May-08 P

Underlying Size
Exp
CP
GSENER 10,000,000 06-May-08 P

Exp
K
06-May-08

Exp
K
06-May-08

UP?
FALSE

Start
End
Bar
05-May-08
06-May-08

UP?
TRUE
TRUE
TRUE
TRUE
TRUE
TRUE

Start
End
Bar
05-Nov-05
06-Nov-05
05-May-06
06-May-06
05-Nov-07
06-Nov-07
05-May-07
06-May-07
05-Nov-07
06-Nov-07
05-May-08
06-May-08

90
90
90
90
90
90

Barr1
KO?
TRUE

UP?
FALSE

Start
End
Bar
05-Nov-05
06-Nov-05

Rebate
90 6.85

UP?
FALSE

Start
End
Bar
05-May-06
06-May-06

Rebate
90 9.66

UP?
TRUE

Start
End
Bar
05-Nov-05
06-Nov-05

90

UP?
FALSE

Start
End
Bar
05-Nov-07
06-Nov-07

Rebate
90 12.30

UP?
TRUE
TRUE

Start
End
Bar
05-Nov-05
06-Nov-05
05-May-06
06-May-06

90
90

UP?
FALSE

Start
End
Bar
05-May-07
06-May-07

Rebate
90 14.82

UP?
TRUE
TRUE
TRUE

Start
End
Bar
05-Nov-05
06-Nov-05
05-May-06
06-May-06
05-Nov-07
06-Nov-07

90
90
90

UP?
FALSE

Start
End
Bar
05-Nov-07
06-Nov-07

Rebate
90 17.23

UP?
TRUE
TRUE
TRUE
TRUE

Start
End
Bar
05-Nov-05
06-Nov-05
05-May-06
06-May-06
05-Nov-07
06-Nov-07
05-May-07
06-May-07

90
90
90
90

UP?
FALSE

Start
End
Bar
05-May-08
06-May-08

Rebate
90 19.50

UP?
TRUE
TRUE
TRUE
TRUE
TRUE

Start
End
Bar
05-Nov-05
06-Nov-05
05-May-06
06-May-06
05-Nov-07
06-Nov-07
05-May-07
06-May-07
05-Nov-07
06-Nov-07

90
90
90
90
90

Barr1
KO?
TRUE
Barr2
KO?
TRUE

Barr1
KO?
0 TRUE
Barr2
KO?
TRUE
TRUE

Early Redemption Amount(i): see table below

Barr1
KO?
FALSE
Barr2
KO?
TRUE
TRUE
TRUE
TRUE
TRUE
TRUE

Barr1
KO?
TRUE
Barr2
KO?
TRUE
TRUE
TRUE
Barr1
KO?
TRUE
Barr2
KO?
TRUE
TRUE
TRUE
TRUE
Barr1
KO?
TRUE
Barr2
KO?
TRUE
TRUE
TRUE
TRUE
TRUE

Rebate
55

0
Rebate
0
0
0
0
0
0

Rebate
0

Rebate
0
0

Rebate
0
0
0

Rebate
0
0
0
0

Rebate
0
0
0
0
0

Autocalls: Implied Digitals

Bet-size = 1 + coupon df
5 year USD df = 0.78
Standard market size = 50m => Implied Bet ~ 10m
Digital = Notional * max [s-k,0] Notional * max [s(k+dk),0]
=> Notional = Bet-size / dk

12,000,000.00

10,000,000.00

8,000,000.00

6,000,000.00

Metal
Cu
Al
Ni
Pt
Zn
Pd
Pb
Ag
Sn

Price
5,500
2,600
33,000
1,100
3,880
330
1,600
12
11,000

10,000,000
Volume:Da
2% Lots per tonVolume
110
25
3,636
1.0
52
25
7,692
0.7
660
6
2,525
1.4
22
1
454,545
8.9
78
25
5,155
1.8
7
1
1,515,152
29.1
32
25
12,500
10.2
0
1
41,666,667
44.3
220
5
9,091
43.1

4,000,000.00

2,000,000.00

80

85

90

95

100

105

110

115

Autocalls: Intra-asset correlation risk

Fwd1

Fwd2

110

105

Intrinsic
0%

KI? * Instrinsic
0
0%

95

5%

0%

105

0%

0%

95

5%

5%

100

100

90

Correlation
-100%
0%
+100%

100

E[KI Put]
0%
1.25%
2.5%

Case Study 4: Dispersion

Buyer receives:

Not *

Com mod ity i ( final ) Com mod ity i (initial )

1 n

*Max 0%,

n i =1
Com mod ity i (initial )

Where:
For i = 1 to n, n being the number of commodities in the basket
Commodityi (initial): The Official Closing Price of Commodity i as of the Strike Date.
Commodityi (final): The Official Closing Price of Commodity i as of the Expiry Date.
Not = Basket Notional Amount
NB: Currency of payoff USD.

Seller receives:

Not *

1 n Com mod ity i ( final ) Com mod ity i (initial )

Max 0%,
n
Com
mod
ity
(
initial
)
i
=
1
i

Where:
For i = 1 to n, n being the number of commodities in the basket
Commodityi (initial): The Official Closing Price of Commodity i as of the Strike Date.
Commodityi (final): The Official Closing Price of Commodity i as of the Expiry Date.
Not = Basket Notional Amount
NB: Currency of payoff USD.

Case 4: Dispersion Payoff

Asset1

Asset2

110

120

Buyer
15%

Seller Dispersion
15%
0%

80

5%

0%

5%

120

10%

5%

5%

80

0%

0%

0%

100

100

90

Correlation
-100%
0%
+100%

100

E[Dispersion]
5%
2.5%
0%

Aviation and Exotics rule:

Take-offs are optional

Landings are mandatory