Autocallable Pricing, Structuring, Hedging, and Exotic Desk PnL

# Exotic Trading Basic Questions - Banking


# Exotic Trading Basic Questions - Banking












I just joined a support team for an equity exotic trading desk in a bank, I am looking for a high level overview of how exotic trading works in a bank.

For my questions let's take a common product: an Autocall on a stock with barriers: KO 100% and KI 70% with valuation every 6 months. Here are a few questions I currently have.

I never studied Finance an have some trouble to understand a few basic topics, any answer even partial is welcome.

- Pricing

What does it mean to "price" an Autocall. When the client buy an Autocall does he pay a premium like for an option ? or is it the KI barrier paying for the structure ? what is the price then ?

- Structuration

What does it mean to structure an Autocall ? I understood an autocall can be composed of a put down and in / barrier options, bonds for the coupon, etc.

Does it mean if the client buy an Autocall the bank will buy a put down and in and a bond to hedge, how does it work and what is structuration ?

- Risk management

On a high level how do traders hedge their risk, I understand they compute the greeks like for options.

What is the impact of the current positions and risks on the price of a product, can some products / autocall you sell to client help you hedge your risk, is it common ?

Do they usually lose money on the hedge (e.g. they sell the product and then need to hedge during the whole lifetime) ? I've heard of gamma trading, can they make money with the hedge, etc.



How is the trading desk in a bank making money ? with a premium, by managing risks, do they take directional position and don't hedge themselves completely ? what usually drives the PnL of an exotic desk in a bank ?

Is this correct:







How does it work for daily PnL, is the margin making most of the profits.

I just would like to have a high level overview of how it works. If you have any material to get started don't hesitate to send a link.

Thanks a lot for your help !

## Answer by will (score 4, accepted)

https://quant.stackexchange.com/a/46735

- "pricing" am autocallables is simply working out what it's worth. This is done by having some model (Google local vol / stochastic local vol) which is calibrated to the market (ie listed vanilla options, broker quotes for less liquid tenors, and some light exotics (ie American barriers, cliquetes, etc.)), and then simulating the underlying many times, calculating tee underlying value on each path, and then averaging them (monte carlo). Typically, you won't calculate the price of a particular autocallables, rather you'll find the value of the coupon/barrier such that the structure is worth 100%. A client will normally ask their advisor/wealth manager for a level on a structure, and they will ask multiple issuers, each will give a barrier/coupon for the same structure, and the client will pick the one that is most attractive.

- Structuring can mean a few different things. Be it adding features to a structure in order to tailor it to a clients wishes, or maybe better achieve the exposure they're after, or it may simply be choosing the strike level. It may go farther and involve creating a whole new style of structured product (ie. Kick in goals, mountain range structures, cliquetes, accumulators, range accruals, prdcs, tarns, lizards - they're all different structured products created for various reasons).

- Typically the exact trade is not hedged, as its extremely expensive. Instead, the Greeks up so some desired order msy be hedged. In reality, the position is added to the portfolio of hundreds of other structers, and the risk from all amalgamated. Some risks offset, this is good - your new structures (at least at the moment hedge your old ones). Others increase your risk. As the market changes, your risk will change. Managing the risk simply means to keep your risk inside sensible limits, and minimise it where its financially viable (it is possible to get it to zero, but very expensive. Risk management also must take into account the costs of the hedges. Leaving some risk on the table is acceptable, if you're getting paid for it).

- A structured desk makes money by selling things for more than they are worth. It is that simple - in point one, I mention that you solve for the couoin such that the price is 100%. This is not quite true, in reality, you solve for the couoin such that the value is (say ) 99%, amd sell it for 100%. If you then hedge the trade for zero cost (unrealistic) through the life of the trade, you make 1%. What actually happens is that your hedges incur trading costs. Provided those costs are lower than the value of the trade, and the total of the position and the hedges' pnls are greater than the remaining amount, you make money. You could take more pnl on day 1, to give you more leeway in the hedging costs, but then your price will be less competitive and you reduce your odds of winning the trade.

Hope that helps.