Leverage at Big Family Offices

[Robert Morse]

Steve Cohen, is the real Wall Street dog and my trading icon.Normally, i have no idols at all.

I think I have told this story before, but I was an AMEX wire clerk and then floor broker from 1982 to 1984. We had a wire that said, "Stevie Grunthal". I did not realize that was "THE' Steve Cohen until around 5 years ago. He legged into option reverse/conversions. It was the easy money back then, but we had to be very fast to get the trades done.

In the mid 90's, I had a close friend that was the Head Risk Manager for SAC. He brought me up there twice to try and get an allocation to start an option desk. Ultimately, we decided that only a market maker operation made sense at that time and they did not want to own more than 10% of a BD as they would loose their profitable IPO allocations.

I would not say that Steve Cohen is my idol, especially after reading Black Edge. If even 25% of that is true, he is lucky to not be in jail and the bulk of his returns were suspect. Either way, he is one of the best traders in the world and gives a lot of money to charity.

Bob

 

[fordewind]

I think I have told this story before, but I was an AMEX wire clerk and then floor broker from 1982 to 1984. We had a wire that said, "Stevie Grunthal". I did not realize that was "THE' Steve Cohen until around 5 years ago. He legged into option reverse/conversions. It was the easy money back then, but we had to be very fast to get the trades done.

In the mid 90's, I had a close friend that was the Head Risk Manager for SAC. He brought me up there twice to try and get an allocation to start an option desk. Ultimately, we decided that only a market maker operation made sense at that time and they did not want to own more than 10% of a BD as they would loose their profitable IPO allocations.

I would not say that Steve Cohen is my idol, especially after reading Black Edge. If even 25% of that is true, he is lucky to not be in jail and the bulk of his returns were suspect. Either way, he is one of the best traders in the world and gives a lot of money to charity.

Bob

He`s not in jail so everything is ok.Even, if you ve committed a crime and not in jail, you did nothing.

 

[newwurldmn]

Depends on the asset class, I suppose...

You can use working capital (e.g. total margin, haircut, etc), gross notional and/or MV, gross risk factor (e.g. vega or delta or whatevers), on top of VAR. You can also limit exposure based on max DD in stress tests. Then pick the "worst of" to enforce.

For risk management. But how do they compare to the balance sheet usage. That would either be margin or notional or something. Would Point72 call their option premiums as their capital, notional, or some risk management metric (like 50x 99% VaR)?

 

[Martinghoul]

For risk management. But how do they compare to the balance sheet usage. That would either be margin or notional or something. Would Point72 call their option premiums as their capital, notional, or some risk management metric (like 50x 99% VaR)?

I am really not sure what "balance sheet" means for derivatives exactly. In my mind, "balance sheet" is a concept which is primarily associated with cash securities. For derivatives, I guess "total working capital" is the closest notion, since, in accounting terms, it represents cashflows.

So, say, a PM buys a bunch of options and spends a total of $1mio of premium. Apart from VAR, stress and all the other risk-related metrics, the firm could also look at and constrain the net and/or gross premium and/or the total working capital. Assuming the option is daily margined, the working capital consumption for this trade will be some fraction of the total premium (just a matter of exch or OTC margin). All of these things are, in one way or another, imperfect measures of leverage, each with its own advantages and caveats.

 

[sle]

In the case of Point72, they used to run 3.5x leverage and now they are 8x levered.

In this case, things are not what they appear. I happened to know first-hand.

 

[newwurldmn]

I am really not sure what "balance sheet" means for derivatives exactly. In my mind, "balance sheet" is a concept which is primarily associated with cash securities. For derivatives, I guess "total working capital" is the closest notion, since, in accounting terms, it represents cashflows.

So, say, a PM buys a bunch of options and spends a total of $1mio of premium. Apart from VAR, stress and all the other risk-related metrics, the firm could also look at and constrain the net and/or gross premium and/or the total working capital. Assuming the option is daily margined, the working capital consumption for this trade will be some fraction of the total premium (just a matter of exch or OTC margin). All of these things are, in one way or another, imperfect measures of leverage, each with its own advantages and caveats.

Balance sheet: if you buy an 50 strike call for $1 (spot = 50), you use $1 of balance sheet. If you buy a put for $1 and and a share of stock, you use $51 of balance sheet. Notional values are the same. Risk is the same.

How do funds typically account for derivatives on their books? When I traded institutionally, we were penalized for the married put because we were charged for balance sheet at fed funds plus a spread. But there was no practical limit on how much balance sheet we used.

I'm curious how Point72, Citadel, Millenium, etc looks at capital with respect to derivatives. There must be some formula.

 

[Martinghoul]

Balance sheet: if you buy an 50 strike call for $1 (spot = 50), you use $1 of balance sheet. If you buy a put for $1 and and a share of stock, you use $51 of balance sheet. Notional values are the same. Risk is the same.

How do funds typically account for derivatives on their books? When I traded institutionally, we were penalized for the married put because we were charged for balance sheet at fed funds plus a spread. But there was no practical limit on how much balance sheet we used.

I'm curious how Point72, Citadel, Millenium, etc looks at capital with respect to derivatives. There must be some formula.

Yea, so this notion of balance sheet as defined by simply "how much cash is sent out the door" is probably pretty universal... This can be constrained and often is.

However, your typical "off-balance sheet" derivative, like an on-mkt swap of some sort, will give you leverage with no balance sheet consumption, at least at inception.

There is no real formula. As I mentioned before, people can look at everything and then choose the constraints they feel work the best for them. So things will look quite different between Citadel and Millennium, for instance. Furthermore, these things evolve over time, depending on regulations, fund structure, etc.