Handbook of Finance: Financial Markets and Instruments

Chapter 15. OTC Equity Derivatives

BRUCE COLLINS, PhD

Professor of Finance, Western Connecticut State University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

Abstract: The development of the OTC equity derivatives market offers investors investment opportunities that are simply not available in the listed market or cash market. The international banking community has created a marketplace that has improved the efficiency of investing. Serious investors can no longer ignore the value of using OTC derivative products as a major part of their overall investment strategy. It is incumbent on plan sponsors, money managers, insurance companies, mutual funds, and corporations to consider the use of equity derivatives in achieving their investment objectives. The OTC equity derivatives market can be divided into three main components: OTC options and warrants, equity-linked debt instruments, and equity swaps. OTC equity options are customized option contracts that can be applied to any equity index, basket of stocks, or an individual stock. Equity derivatives have a variety of applications to investment management. Among the considerations for equity portfolio management are ways to take advantage of promising returns through the reallocation of funds within the portfolio. This portfolio rebalancing might include sector rotation, international diversification, style rotation, or return enhancement. These strategies mostly focus on stock selection ...