Financial traders - instruments and shares: synthetic positions
Synthetic positions and trading
Financial transactions include the acquisition, holding, dealing with, and disposal of financial assets such as shares and bonds. They also include taking synthetic positions in relation to such assets or corresponding indices, or discrete components of them. In our view, using synthetics is not itself indicative of trading. There is no conceptual difference between a ‘real’ and a synthetic financial transaction (for example, buying a share or entering into a derivative contract that replicates the risks and rewards of ownership). All of these approaches may form part of an investment strategy and some of them may constitute investment in themselves.
Short positions are conceptually the same as long positions
Buying a share because you take the view that its price will rise and shorting a share because you think its price will fall are conceptually the same. In simple terms, a view is merely being taken on the direction of movement. It follows that synthetic long and short positions are conceptually the same as one another and the equivalent real transactions.
Derivatives that give exposure to part of an asset are conceptually the same as derivatives that give exposure to the whole asset
A view may be expressed on a bundle of components embedded in an instrument, for example the coupon, liquidity, credit risk and currency of a bond, or alternatively a view may be expressed on one or a combination of these components. There is no conceptual difference between taking a view on all components by buying the instrument or entering a derivative contract that replicates ownership, or taking a view on one or a combination of the components via derivatives. There is no conceptual difference between taking a view on the direction of movement (as with simply long and short positions) or taking a view on the magnitude or timing of movements, or other components.
Multi-derivative or hybrid strategies should not be unbundled.
Given the wide range of situations this principle can apply to, three examples are set out below. These are intended to be illustrative and not a definitive list.
In all cases involving any such ‘bundling’ we would expect there to be evidence that the transactions were executed in pursuit of a clear prior strategy.
Two or more derivatives
Where, for example, the view is that the price will increase but only within a certain band, and the most efficient way to express that single view is via a series of derivative transactions, those transactions should be considered as a whole and not each in isolation.
A derivative and another financial asset (for example shares)
Where the view is that an asset would not be acquired at current value but would be at a set lower value, a put option is written at that lower value, i.e. as a cost efficient method of acquisition. The writing of the option and the potential acquisition of the asset should be considered as a whole and not each in isolation
A sequential series of similar derivative strategies
A derivative that is close to maturity generally has greater liquidity than a derivative identical in every way, other than having a longer period to maturity. ‘Rolling’ short dated derivative strategies such that there is a sequential series of similar derivatives should be viewed as a whole and not each in isolation.