MSNBC – The recent distortions to equity prices that traders have created by adjusting their positions in derivatives based on market volatility should disappear in the next two to four weeks,Citigroup, the US bank, said on Tuesday.
The bank said that although this derivatives activity appeared to have exacerbated the recent swings in European equity prices, banks and hedge funds were rebalancing their books. This suggested that the distortions would eventually evaporate from the markets, it said.
“Given current market conditions, the exacerbating effects of derivative hedging might be expected to be noticeable for another 2-4 weeks,” said Gerry Fowler, equity derivatives strategist atCitigroup.
“After that we believe equilibrium will have been restored.”
The market is likely to take close note of his comments. Many traders believe that derivatives hedging has been a big factor in the sharp swings recently in equity markets towards the end of the trading day (around 4pm in London).
One class of derivative contract that has been at the centre of this activity is the variance swap.
This is an instrument that investors can use to place bets on the level of volatility in the markets, without taking a view on the actual direction of the markets.
