1. What is an Accumulator?
Beginning today, we will run a week-long series on the OTC commodity structure known as the Accumulator.
The trade is simple, yet very complex. Understanding the trade, its risks and markups will be the focus of this five part series.
Would you sell options at historically low volatilities to finance a trade? Would you pay away 40% of your repricing while also having short option exposure?
Let’s start off by answering the question, “What is an Accumulator”?
As mentioned last week, the Accumulator entered agriculture by way of the FX market. We were trading a sugar ‘range option’ with a Brazilian sugar producer that paid off the ‘repricing benefit’ only on expiration. The structure was ‘knocking out’ near expiration and the client asked me, “Is there a trade where we can accumulate anything along the way?” From that comment, the accumulating idea was formed. The structure was broken into daily and weekly expirations giving the clients swaps or futures at the better price.
An accumulator is a combination of puts and calls broken into ‘strips’. Let’s use the basic daily expiration for a Producer as an example.
1. The Producer is granted a daily strip (expires every day) of in the money (above current market) puts that knock out below current market. Why the ‘knock out’? It makes the in the money puts cheaper.
2. The Producer grants (sells) two out of the money (same strike as puts) call strips. These also knock out at the same barrier below. Knocking out, out of the money does not degrade the price as much as the put that knocks out in the money.
3. The combination ‘pays off’ in the following way:
a. If at the end of the day, the underlying market is under the put strike and has not touched the barrier, the Producer will ‘accumulate’ a swap or futures contract.
b. If the market is above the put/call strike, the short calls form an obligation to sell 2X the quantity. The Producer accumulates double the short swap or futures.
c. If the market touches the lower barrier at anytime during the life of the trade, the structure is knocked out and ceases to exist. All swaps/futures accumulated to date are retained by the Producer.
4. The Trade is marketed at ‘zero cost’, which we will discuss later in the week.
5. There are many forms of this trade:
a. The above Daily or Weekly expiration.
b. The calls all expire at the end so it makes the put strike higher.
c. The trade fixes a minimum number of swaps or futures.
d. The repricing levels are tiered or laddered.
e. The structure does not have a knock out.
f. The structure has many ingenious names...and so forth.
Part 2 of the Accumulator Series tomorrow...
Pack Creek Capital constructs and manages hedge portfolios for companies in the grains, softs and energy markets. Contact mbradbury@packcreekcapital.com for more information.
