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Hedge Fund All-or-Nothing Trades Gain Traction in Options Market
(Bloomberg) -- With events from elections to central-bank rate moves to wars threatening upheaval in the markets, investors are increasingly seeking a pre-determined payoff if they bet right.
While many traders — from mom-and-pops to systematic hedge funds — are using zero-day-to-expiry listed options, large investors have increasingly turned to over-the-counter binary contracts that can hedge tail risks across multiple assets.
It’s an all-or-nothing play: in exchange for a premium, the trade either returns 100% or nothing. While critics say it’s more akin to betting on a sporting event than traditional options trading, the reality is that such a binary payoff is extremely useful to investors focused on hitting target returns within strict risk limits.
“Cross-asset dual binary option trades have picked up around event risk this year,” said Herve Guyon, head of flow strategy and solutions at Societe Generale SA.
While judging the size of the market is difficult given all trades are over the counter with multiple counterparts, estimates for the premium spent in 2024 on such structures run from several hundred million to a billion dollars.
This year has been full of event risks: from elections in the US, Europe and India to “live” Federal Reserve meetings, an active Bank of Japan for the first time in decades, the prospect of massive stimulus in China, the escalating war in Ukraine and simmering tensions between Iran and Israel that threaten to boil over.
One of the biggest key events was the US presidential vote. The nation’s stocks have risen in the aftermath, buoyed by optimism that Donald Trump’s policies will boost share prices. But in Europe and China, Trump’s election brings the threat of tariffs and a more contentious trade policy that could be a drag on profits of companies in those markets.
“The chase for the upside following the passing of the election uncertainty and into year-end is being reflected in elevated call skews across US indexes,” said Tanvir Sandhu, Bloomberg Intelligence’s chief derivatives strategist. “Europe on the other hand faces tariff risks, where hybrid options (such as equity down, EUR/USD down) typically increase leverage and reduce costs.”
Key events are what make the cross-asset trades appealing. The so-called dual digital (or binary) options need multiple conditions to be met before a contract buyer receives a payout — for example if “X” happens in equities and “Y” happens in currencies. The gain is limited to a specific payoff, in contrast to vanilla options, which can return more if the market moves further beyond their strike.
UBS Group AG strategists last week touted one such trade to capitalize on post-election bets: a three-month dual digital combining the S&P 500 Index falling below 96.15% of its current level and spot gold retracing some of its recent decline. Both conditions have been met recently, and the strategists saw the trade acting as a “convex” hedge if share prices weaken, protecting against tail risks.
Before the US vote, Barclays Plc strategists highlighted a “Trump’s triumph = Trade tariffs = Trouble for EU assets” scenario, where a win by the now president-elect could hit both European equities and the euro. In a note, they promoted a December dual digital option with the Euro Stoxx 50 Index at less than 97.5% of its level at the time, paired with euro-dollar at less than 98%.
Another trade that gained traction before the election was a permutation of the Trump Trade, according to Guyon. It involved the Russell 2000 Index rallying due to the perceived improvement in domestic conditions favoring US small-cap stocks, with any China proxy — such as the Australian dollar — weakening.
“The market for dual binary hybrid options has definitely grown this year,” said Uriel Kutnowski, head of tactical solutions sales at BNP Paribas SA. Clients, who mostly trade equity/rates or equity/FX products, spend an average $750,000 per trade and can make $10 million if their view is right, he said.