The world of derivatives is continuing to grow at a rapid pace, and it is now being driven by the growth of the retail investor. For years, the derivatives markets was dominated by institutional players, who used derivative products to speculate on the markets, or hedge exposure. The binary options markets has historically been dominated by large banks, hedge funds and mutual funds. These companies are now sharing the spotlight with the insurgence of the retail investor.A bank is a financial institution that raises capital, trades securities and manages corporate mergers and acquisitions. Commercial banks generally concentrate on lending and consumer banking but are involved as well in all aspects of an investment bank. Investment banks work for, and profit from, companies and governments, by raising money through issuing and selling securities in capital markets (both equity and debt) and insuring bonds and providing advice on transactions such as mergers and acquisitions. A majority of investment banks offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity, and equity securities.
Banks trade their own capital as well as on the behalf of their clients. Banks supply their clients with a conduit which enables investors access to numerous markets. Many banks have platforms that are designed to allow for easy access to financial instruments that are traded on exchanges, as well as, allow direct access to the derivatives markets via over the counter trading. Historically, banks and investment banks have been the market makers in derivates and specifically binary options. There are now a number of new players/brokers who are catering to the retail market.
Structuring has been a relatively recent activity as derivatives have come into play, with highly technical and numerate employees working on creating complex structured products which typically offer much greater margins and returns than underlying cash securities. Strategists advise external as well as internal clients on the strategies that can be adopted in various markets. Ranging from derivatives to specific industries, strategists place companies and industries in a quantitative framework with full consideration of the macroeconomic scene. This strategy often affects the way the firm will operate in the market, the direction it would like to take in terms of its proprietary and flow positions, the suggestions salespersons give to clients, as well as the way structures create new products. Banks also undertake risk through proprietary trading, done by a special set of traders who do not interface with clients and through “principal risk”, risk undertaken by a trader after he buys or sells a product to a client and does not hedge his total exposure. Banks seek to maximize profitability for a given amount of risk on their balance sheet. The necessity for numerical ability in sales and trading has created jobs for physics, math and engineering Ph.D.s who act as quantitative analysts.
In a completely separate area of a financial institution are groups that cater directly to clients. These groups are brokering areas that execute and clear trades for clients of the bank. Some of these areas have clients that work for hedge funds or mutual funds or investment advisors that need to execute traders on a low latency network. These clients will also trade strategies that are similar to the strategies traded at the bank. These clients expect their broker to execute trades at the very best prices and as quickly as their own proprietary trading operations.
A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of investment and trading activities than long-only investment funds, and that, in general, pays a performance fee to its investment manager. Hedge funds are usually available to accredited investors which are investors that have a liquid net work of more than 1 million dollars. Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including equity shares, debt and commodities.
As the name implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety of methods, most notably short selling and derivatives. However, the term “hedge fund” has also come to be applied to certain funds that do not hedge their investments, and in particular to funds using short selling and other “hedging” methods to increase rather than reduce risk, with the expectation of increasing the return on their investment.
Hedge funds are usually clients of banks (commercial and investment banks – or brokers) and rely on these institutions to execute electronic trading strategies that require low latency technology.
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other types of securities. The mutual fund will have a fund manager that trades the pooled money on a regular basis. The net proceeds or losses are then typically distributed to the investors annually.
Within the mutual fund world there are plethora’s of trading strategies that are employed. The majority of the strategies are managed, meaning that a money manager directly makes decisions or the deployment of the trading strategy. There are also many strategies that are index driven and are completely passive.