Synthetic Prime Strategies


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The following strategies are all predicated on simultaneously trading the underlying equity and the corresponding listed equity futures. This simple transaction, called an Exchange-for-Physical (EFP), is the foundation for all synthetic prime transactions. The important differentiating factors are whether a customer is buying (buying futures and selling stock) or selling (selling futures and buying stock) the EFP and the customer’s residual position after the EFP. An EFP transaction bears no equity market risk and the investor’s underlying equity exposure remains unchanged: (i) long equity holders will hold an equivalent long futures position after an EFP, (ii) equity short positions will be replaced by short futures positions, and (iii) long cash players will hold offsetting positions. Regardless of the strategy, the OCC will return the original equity position into the customer’s account at the futures expiration.

Synthetic Primes strategies are term in nature – usually thirty (30) to ninety (90) days – and subject to changes in implied rates during the life of the contract. Synthetic mark-to-market prices relative to the underlying equity may vary as implied rates vary and may result in unexpected gains or losses. Unwinding a synthetic position prior to expiration may also result in unexpected gains or losses.

Equity Financing

As an alternative to traditional financing, equity investors can utilize Single Stock Futures to finance existing long equity positions or synthetically replicate equity holdings. Through the SSF market, investors can reach a greater breadth of capital providers and benefit from current the AAA/AA+ credit rating of the Option Clearing Corp. (OCC) to lower their cost of financing.

For investors looking to leverage their portfolios, Single Stock Futures offer up to eighty percent (80%) financing or 5:1 leverage. Reg T limits traditional equity financing at fifty percent (50%) or 2:1 leverage. For prime brokers that offer portfolio financing, SSFs can be incorporated into the risk based metrics used to calculate portfolio financing ratios.

Foreign and Offshore U.S. Equity Financing

As a simple financing transaction, Single Stock Futures have been adopted by mutual funds, UCITS and hedge funds as a tax efficient means to improve the performance of their existing equity portfolios. Current withholding tax legislation for foreign and offshore investors has exempted SSFs from dividend tax withholding. Following our meetings with the U.S. Treasury and the IRS, we believe this exemption to be based on the economic characteristics of the product, especially the fact that SSFs are indifferent to or entirely “forgoes” the dividend process.

Foreign and Offshore U.S. Equity Financing

As a simple financing transaction, Single Stock Futures have been adopted by mutual funds, UCITS and hedge funds as a tax efficient means to improve the performance of their existing equity portfolios. Current withholding tax legislation for foreign and offshore investors has exempted Single Stock Futures from dividend tax withholding. Following our meetings with the U.S. Treasury and the IRS, we believe this exemption to be based on the economic characteristics of the product, especially the fact that Single Stock Futures are indifferent to or entirely “forgoes” the dividend process.

 Stock Borrowing/Lending

Stock lending has traditionally been controlled by a limited number of financial institutions. Single Stock Futures (SSF) have democratized the market by allowing the end users – beneficial owners and short players – to interact directly with each other without concerns for creditworthiness. In gaining direct access to this financing market, beneficial owners and short players can maintain control of the monetization of their assets, reduce their costs and achieve superior pricing.

Single Stock Futures monthly contract expirations provide borrowers and lenders the opportunity to lend or borrow for predetermined terms. These set maturities provide predefined returns for lenders and the ability for short players to lock in a borrow rate for a specific duration without risk of recall. The existence of multiple monthly expiration creates an effective borrow “curve” for each stock.

The Single Stock Futures market allows beneficial owners to actively manage the value of their equity holdings to generate incremental portfolio returns. The market allows short players to manage their books in a similar fashion, while also providing the unique opportunity to be compensated to borrow selective stocks.

Cash Management

The growth in the Single Stock Futures market coupled with the capital constraints that traditional financing institutions are now facing have created the opportunity for non-traditional cash rich institutions to enter the equity financing market. Through a Single Stock Futures EFP, cash managers are able to invest their cash in an AAA/AA+ short-term instrument and generate LIBOR + returns on their investment. At expiration of the listed SSF contract, the amount of cash invested plus the incremental returns are returned via the OCC’s guaranteed delivery process. Traded as a spread, neither the Single Stock Future EFP nor the OCC position unwind bear price or execution risk.