"Economic Derivatives" Offer a New Option

September 12, 2002 (PLANSPONSOR.com) - Investors bored with trying to gauge the direction of such commonplace investments as stocks, bonds and pork bellies will soon have a new option - economic derivatives.

Beginning next month, traders will be able to invest in a new options market, as Goldman Sachs and Deutsche Bank unveil options trading on US economic data releases such as retail sales and manufacturing.

The options allow hedge funds and institutions to bet specifically on the outcome of the data. At the start, only professional traders will have access to the market, but eventually, individual investors will also be allowed to trade economic derivatives, Reuters said.

Goldman and Deutsche will offer the options initially on US payrolls, retail sales and the Institute for Supply Management’s manufacturing index. Eventually, the banks hope to expand the options to US inflation gauges and foreign data, the Reuters story said.

The project kicks off with an October 1 auction in which participants may acquire either calls, which are options to buy, or puts, which are options to sell, and they can set limits on the amount they are willing to pay, according to the report.

Traders also must choose a strike, which is the option holder’s forecast for the data. A call struck either at or above the data’s headline reading is a winner. While a put at or below the reading also wins. For example, a trader with a call at 100,000 makes money if nonfarm payrolls rise by 100,000 jobs or fewer, the Reuters story explained.

Goldman and Deutsche might offer strikes for the payroll number from a negative 150,000 jobs to a positive 250,000 jobs in increments of 50,000. If a concentration of bids builds up at a particular level, those calls become increasingly costly, because it shows that a disproportionate number of investors expect the payroll number to come in near there. Consequently the payoff is less.

The firms expect healthy interest in the new derivatives, but the message has yet to reach all ears. Several options strategists said economic derivatives will have a hard time competing with tried and true hedging instruments such as Treasury and currency futures, Reuters said.