Equity OTC Swap/ Option - key risks and features


An Equity Swap, either a Price (PRS) or a Total Return Swap (TRS), contract is an agreement where cash flows are exchanged between parties where the first party makes payments based on returns on a single equity and the counterparty makes payments of a fixed amount and/or
floating amount or payments based on the returns of the notional amount of the contract.

An Equity Option contract provides the right, but not the obligation, to buy or sell a quantity of stock , at a set price, within a certain period of time or at a specific point in the future. This right is monetised through the exchange of a cashflow called the premium, which in turn impacts the pricing of the strike price of the option which is payable/receivable on exercise of the option.

Both derivatives can be used to generate or manage exposures to equity positions in similar ways and with similar risks.

Key risks and features

  • Market Risk

    • Market risk can materialise due to macroeconomic factors and may have an impact on a particular instrument or more broadly on equity markets as a whole.
  • Credit Risk

    • By entering into a bilateral contract a client is taking on a credit risk to Investec Bank plc.  In the event that Investec should default on its obligations or become insolvent, a client may not receive back the full value of their transactions.
  • Volatility Risk

    • In adverse market conditions volatility can increase and this will lead to greater market risk.  In normal market conditions volatility in equity markets will vary between individual equities.
    • In more volatile market conditions clients may be subject to a wider spread with regards to pricing available.
  • Liquidity Risk

    • Equity Swap/ Option market liquidity is dependent on the underlying equity in question and bilateral appetite at the point of trade.
    • In markets with less liquidity, clients may be subject to a wider spread with regards to pricing available. 
  • FX Risk

    • Clients entering into Swap/Option contracts that are priced in the same currency as the underlying are not exposed to direct FX risk.
  • Concentration Risk

    • Concentration Risk is not applicable to these products.
  • Conflicts Risk

    • Investec may take and /or hold positions that conflict with those of our clients, more details around the treatment and execution of client orders can be found in the Order Execution policy which can be found on the website.
    • Conflicts arising, from Investec’s business model, such as the one noted above, are managed through internal controls and process and is detailed in the Conflicts of Interest policy which can be found on the website.
  • Transparency

    • Equity markets are very transparent with up to date pricing available online. Pricing around other Equity instruments such as these products is not as transparent, though Equity derivative pricing and calculators can also be found online or on Bloomberg.
    • Where markets are less transparent it can be challenging to form an independent assessment of a contract’s fair value. 
  • Margin Risk

    • Investec may, from time to time, request that a client posts collateral against a particular position.  These funds are required in order to protect Investec from losses should a client default on their obligations or become insolvent. 
    • Funds held by Investec as collateral will be held as follows: 
      •    MiFID Professional clients: Collateral held for MiFID  Professional clients will be held in a margin account under a Title Transfer Collateral Arrangement (“TTCA”). A TTCA  is a legal arrangement that gives Investec ownership of the clients margin funds whilst they are in possession of the Bank. Investec can therefore utilise these funds as required for liquidity or investment purposes as is deemed necessary.
    • A client that has funds held by Investec as collateral is also exposed to the credit risk outlined above.
  • Contingent Liabilities

    • Contingent Liabilities are not applicable to these products.
  • Exit Costs

    • These products do not have explicit exit fees that are payable should a client wish to close a position early, however, there may be costs involved in this process depending upon market conditions at the time the client wishes to exit. A client may not be able to redeem the full original value of the contract.
    • A client’s ability to exit early will also be dependent upon the liquidity of the market at the time, should a market be illiquid at the point of early exit then the exit costs are likely to be more significant.
    • There is no cost associated with exiting a product on expiry or at the end of its recommended holding period.
  • Leverage

    • Leverage is not applicable to these products.
  • Interest Rate Risk

    • Clients entering into contracts such as these will have Interest Rate risk linked to the pricing of the product or the swap flows.  Changes in interest rates will have a direct impact on the product’s pricing, as such fluctuations in interest rates will have an impact on the market risks facing clients.