Template:M summ Equity Derivatives 8.7

Equity Amounts, then. Straightforward enough: Take your Equity Notional Amount — helpfully filled out in the Confirmation — multiply it by the Rate of Return, being the performance of the underlying share over the period in question — and there’s your number.

The basics: a worked example.

Let’s put some numbers on this, because, as with many of the finer creations of ISDA’s crack drafting squad™, there is quite a lot of buried technology in there to unpack.

The first component is the Rate of Return. This is a calculation of the performance of the Share over the period, times a Multiplier which might apply if you are doing some kind of kooky leveraged trade, but more likely will account for capital gains or stamp duty payable by the broker on the underlying hedge — so you might expect something like 85%. But that makes the mathematics too complicated for this old fellow, so let’s call the Multiplier 100%, so you can ignore it, and say the Initial Price is 100. And let’s do two scenarios: where the stock has gone up — here say the Final Price is 105, and where the stock has gone down — here, say the Final Price is 95.

The Rate of Return formula is (Final Price - Initial Price)/Initial Price) * Multiplier, which works out as:

• Where the stock went up: (105-100)/100 * 100% = 5/100 = +5%.
• Where the stock went down: (95-100)/100 * 100% = -5/100 = -5%.

Now to calculate your Equity Amount, we take the Equity Notional Amount (for ease of calculation, say USD1,000,000?) and times it by the Rate of Return:

• Where the stock went up: USD1,000,000 * +5% = USD+50,000.
• Where the stock went down: USD1,000,000 * -5% = USD-50,000.

Shorts, longs and flexi-transactions

Now as you know, the ISDA Master Agreement is a bilateral construct — In a funny way, a bit Bob Cunis like that — and while the equity derivatives market is largely conducted between dealers and their clients. This doesn’t mean the dealer is always the Equity Amount Payer. The client — as often as not, a hedge fund — is as likely to be taking a short position — locusts, right? — as a long one. One does this by reversing the roles of the parties in the Confirmation: The Equity Amount Payer for a long transaction will be a dealer. The Equity Amount Payer for a short transaction will be the fund.

So much so uncontroversial. But then there are flexi-transactions: in these modern times of high-frequency trading, unique transaction identifiers and trade and transaction reporting, dealers and their clients are increasingly interested in consolidating the multiple trade impulses they have on the same underlyer into single positions and single transactions: this makes reconciling reporting far easier, and also means you don’t have to be assigning thousands of UTIs every day — at a couple of bucks a throw — to what is effectively a single stock position.

What does this have to do with Equity Notional Amounts? Well, the Equity Notional Amount of that single “position” transaction is now a moving target. A short trade impulse on a (larger) existing long position will reduce the Equity Notional Amount, but it won’t necessarily change who is the Equity Amount Payer, unless the total notional of the position flips from positive to negative. Then it will. This is kind of weird if you stand back and look at it from a stuffy, theoretical point of view, but once you slip into that warm negligee of pragmatism in which almost all legal eagles love to drape themselves, you get over it.

Well, I did, anyway.