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New Derivative Clips Tail Risk

Actuarials Holdings, a Chicago-based company, has launched a new derivative that eliminates tail risk. The product is called a Clipper, as it clips the investment's downside potential as well as caps its upside potential.

Actuarials Holdings, a Chicago-based company, has launched a new derivative that eliminates tail risk. The product is called a Clipper, as it clips a trader’s downside potential as well as caps its upside potential. According to Adam Burczyk, CEO, “The Clipper is a great product for this type of tumultuous market—it is somewhat of an antidote to the whiplash market everyone is experiencing.”

Adam Burczyk, CEO of Actuarials Holdings
Adam Burczyk,
CEO of Actuarials Holdings

The Clipper, which launched on a limited basis 10 months ago, “is designed to guarantee a full opportunity for targeted return for speculative traders, and eliminate excess tail risk/volatility risk,” says Burczyk. He adds, “It also enables short selling on a synthetic basis, so there are lots of things traders can do during this very tumultuous environment. “

The Clipper is designed for fast frequency traders who have a relatively short time horizon in mind and have a targeted return. One of the benefits of the Clipper, besides eliminating tail risk, is that traders don’t have to put a great deal of capital to work to get their targeted return.

Burczyk explains, “Lets say you’re trading a $100 stock and you think the stock is going to go up $2 dollars over the next a week. You might spend $100 on the underlying stock and wait around for a week and hopefully you’ll pick up the $2.” He continues, “You’ve sunk $100 in and you’ve picked up 2% that’s pretty good.”

Another option is using the leveraged environment, where you might be able to get 10 to 1 leverage, if you borrow stock. Then you could get a 20% return on capital, he continues.

Buying a $2 clipper is another option, and Burczyk believes, a better option, in this environment. He explains that the Clipper is a simple instrument and little capital has to be put up to make that same $2 gain.

If a trader bought a $2 Clipper on that same $100 stock, they would only have to have $2 in an account with the firm’s bilateral clearing facility. The trader would capitalize on any gain from 0 to $2 that the stock makes in that time frame. “If it goes up $1.16, the trader will pick that up, if it goes up $2.16, the trader would only pick up $2,” he explains, noting that it is not a shoot the moon type of investment.“If the trader believed the stock was going to increase in value by $5, then they would want to buy a $5 Clipper,” he adds.

The same is true on the downside, if the stock goes down anywhere from 0 to $2, the trader would lose that amount. If it goes down $2.80 the trader would only lose $2. “It’s like a cap gain, cap loss future. It has the cap and floor built in, but the nice thing about it is you are picking up what you want, but you don’t have excess loss risk,” he explains.

“If you think about what has happened over the past few weeks, with this product, you don’t have to worry about losing all of that money,” he says. “I think that’s very important in today’s market where tail risk and excessive volatility risk is so scary that many have stepped out of the market. This is the first safe derivative that is out there in that sense,” Burczyk claims. Burczyk explains that if you are doing a long-term, one-year trade, the clipper is not the right product. It is good for fast frequency traders—and can be as fast as every fifteen minutes. He explains, “We have contracts that expire 27 times a day.”

Currently there are 32 symbols that can be traded as Clippers, which include major exchange traded funds (ETFs) and some of the “high flying, single names” like Google and Exon Mobile. The company has analyzed stocks by which are the most popular and by volatility to come up with its list. More will be added, he notes.

The trades are executed electronically on an electronic OTC trade facility that was built by Actuarial Holdings. The trades are cleared bilaterally---and “we deduct from each counterparty all of the margins from each trader before they are matched,” Burczyk says. On that two-dollar Clipper, $2 would have been deducted before the trade was matched. The system is in essence a dark pool as it bilaterally matches trades anonymously, he explains. “We built the system from scratch, It’s an integrated execution and clearing facility with an order cycle of 2 milliseconds, which includes clearing. We do real time margining and settlements.”

According to regulations, traders must be “eligible contract participants” to access the trade facility. He explains that you have to have $1 million or more in assets under management in a partnership or corporation or your must have $5 million or more if you are a high-net-worth individual. “We can’t do retail trades yet, and we are not yet on an organized exchange — those would require more regulations and approvals,” he says.

Burczyk says there is nothing like this product on the market and that’s because most of the large participants have “over relied on their heavy balance sheets to protect them against the credit and market risks.” All other products like, futures and forwards, options and swaps, they have tails. “None of the major derivative categories are tail free,” Burczyzk claims. “We’ve been trading this product for ten months, our largest depositor is $2.5 million and our smallest is $25,000, but we are now letting other institutions know about it. The market right now is the perfect storm for us.”

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