Simple options thrive in risky world - SuperDerivatives

LONDON (Reuters) - Investors want simple derivative products to cushion the pain of stock market losses and have turned their back on complex, custom-built products which were earning a fortune for investment banks, the head of equities at a leading derivatives pricing firm said.

The collapse of Lehman Brothers - the largest bankruptcy in U.S. history which left the bank facing billions of dollars in derivatives claims - has burnt many investors, choking off demand for more complex options, according to Mikael Benguigui, head of equities at SuperDerivatives.

Such trends were last week acknowledged by Deutsche Bank (DBKGn.DE), which noted lower revenue for equity derivatives sales and trading compared with 2010 as a result of what it said was a more challenging environment and lower client activity.

"The market has changed completely. Banks are not willing to take on risk. There is a general consensus in the market now to avoid going into too-complex, too-exotic options," Benguigui said.

"What we see is that people are pricing fairly simple structured products, fairly commoditised products. It's not what we saw five or six years ago when every month banks were inventing a new product."

The pace of growth in the equity derivatives market has slumped from the 33 percent seen in 2007 - before the 2008 collapse of Lehman - to 9 percent in 2011, according to data from the World Federation of Exchanges. Within that, stock index options are the most popular category and are enjoying the strongest growth.

The timeframe on such products has also shrunk: five-year options are popular, but banks are reluctant to take on the risk of offering products for seven years or longer. This is in contrast to pre-crisis days, when they would quote for 12 years or more, Benguigui, a derivatives veteran who also worked at Citi (C.N) and JPMorgan (JPM.N), said.

"The feedback from the investment banking side is that a lot of them are struggling. We are coming back to less complicated options and less complicated strategy, so it's more plain vanilla. And plain vanilla means less room for margin - it's more liquid, it's easy to put banks into competition," he said.

NO BIG UPSIDE

SuperDerivatives offers equity derivatives pricing tools - from a live platform to a one-off portfolio valuation service - to banks, hedge funds, asset managers, custodians and hedge fund administrators in more than 60 countries.

Among the most popular are so-called reverse convertible securities, which are linked to an underlying stock or index and offer a high coupon.

Upon maturity, if the value of the stock or index is above a certain level, the holder gets back the full investment. Otherwise, they get a pre-agreed number of shares.

Such a product ensures a steady relatively high return, in exchange for which investors give up their right to benefit from any unexpected surge in a share price.

"The big upside - no one really believes in it. There might be moderate upside, but they are happy to have a fixed coupon. Moderate downside can happen and they don't want to suffer on that, so they are happy to have the investment back. If they are completely wrong and something really bad happens, it's no worse than being long the stock from day one," Benguigui said.

"This sort of super-easy product has big, big flows in the UK and also in Switzerland."

Regulation is key to regaining investor confidence in a market where many found themselves unable to exit positions as the global financial crisis unfurled.

"Right now, every regulatory body is pushing for more transparency, better liquidity. They are asking the buy side to be more independent by using a platform where you can price everything independently," Benguigui said.

"When the market changes like this, the volume is going to come back. But ... investment banks are not going to be allowed to do what they did before in terms of taking risk or playing with the capital. I don't think we are going to see huge volumes again on complex instruments where banks were making fortunes."

(Editing by David Holmes)