City & Business: No stopping shares

LAST week we were subjected to the supreme example of how derivative trading is beginning to dominate activity in equity markets. The episode centred on UBS, which spent up to pounds 1bn in a single day buying constituents of the mid 250 index so as to cover a warrant it was selling to clients on the index. As a consequence the mid 250 went through the roof.

Something similar happened to the FT-SE 100 share index in the week before Christmas. Billions of pounds of stock was bought by a major Swiss bank so as to provide hedging instruments for a number of substantial pension funds. The market rocketed as a result.

Even ignoring these huge over- the-counter transactions, it is not uncommon these days for futures activity in equities to exceed the volume that's taking place in the stock market - to use the cliche, the tail is beginning to wag the dog.

Investors use derivatives because they are cheap, efficient, quick, provide a good hedge and, in some cases, avoid stamp duty. Many derivative transactions are also outside the Stock Exchange's control.

To some, however, it looks as if ballooning derivative trading has begun severely to distort movements in the underlying markets. Take that warrant transaction. Investors were buying the warrants as a bet on the mid 250 going up; when UBS moved into the market to cover the position, it became like a self-fulfilling prophecy, a case of the blind leading the blind.

Rubbish, say exponents, and even if this is true, does it really matter? If there were no warrants and other futures instruments available, investors would simply go out and buy the underlying stock instead. The effect would be largely the same: share prices would rise, though perhaps over a longer period of time. The equity market might seem to be at the beck and call of derivative traders, but in truth derivatives merely reflect what people think will happen anyway. Derivatives certainly cause short-term fluctuations but there's no long-term distortion.

Have the traders got it right? For the time being, investors seem intent only on driving the market higher. Good economic news is taken as evidence of recovery and shares move on to higher ground. Poor economic news is seen as evidence that the recovery is faltering and therefore another opportunity to cut interest rates; shares again move on to higher ground. It's become a case of heads I win, tails I win.

There's got to be something wrong with this no-lose logic. One day it's going to come unstuck, but for the time being it's hard to find an equity strategist who agrees. London still looks cheap against continental markets; shares will go higher before they go lower again.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45K: SThree: SThree were established in 1986....

Recruitment Genius: Compliance Manager

£40000 - £60000 per annum: Recruitment Genius: A Compliance Manager is require...

SThree: Talent Acquisition Consultant

£22500 - £27000 per annum + OTE £45K: SThree: Since our inception in 1986, STh...

Recruitment Genius: Experienced Financial Advisers and Paraplanners

Negotiable: Recruitment Genius: This extremely successful and well-established...

Day In a Page

Seifeddine Rezgui: What motivated a shy student to kill 38 holidaymakers in Tunisia?

Making of a killer

What motivated a shy student to kill 38 holidaymakers in Tunisia?
UK Heatwave: Temperatures on the tube are going to exceed the legal limit for transporting cattle

Just when you thought your commute couldn't get any worse...

Heatwave will see temperatures on the Tube exceed legal limit for transporting cattle
Exclusive - The Real Stories of Migrant Britain: Swapping Bucharest for London

The Real Stories of Migrant Britain

Meet the man who swapped Romania for the UK in a bid to provide for his family, only to discover that the home he left behind wasn't quite what it seemed
Cheaper energy on the way, but it's not all sunshine and rainbows

Cheaper energy on the way, but it's not all sunshine and rainbows

Solar power will help bring down electricity prices over the next five years, according to a new report. But it’s cheap imports of ‘dirty power’ that will lower them the most
Katy Perry prevented from buying California convent for $14.5m after nuns sell to local businesswoman instead

No grace of God for Katy Perry as sisters act to stop her buying convent

Archdiocese sues nuns who turned down star’s $14.5m because they don’t approve of her
Ajmer: The ancient Indian metropolis chosen to be a 'smart city' where residents would just be happy to have power and running water

Residents just want water and power in a city chosen to be a ‘smart’ metropolis

The Indian Government has launched an ambitious plan to transform 100 of its crumbling cities
Michael Fassbender in 'Macbeth': The Scottish play on film, from Welles to Cheggers

Something wicked?

Films of Macbeth don’t always end well - just ask Orson Welles... and Keith Chegwin
10 best sun creams for body

10 best sun creams for body

Make sure you’re protected from head to toe in the heatwave
Wimbledon 2015: Nick Bollettieri - Milos Raonic has ability to get to the top but he must learn to handle pressure in big games

Nick Bollettieri's Wimbledon files

Milos Raonic has ability to get to the top but he must learn to handle pressure in big games
Women's World Cup 2015: How England's semi-final success could do wonders for both sexes

There is more than a shiny trophy to be won by England’s World Cup women

The success of the decidedly non-famous females wearing the Three Lions could do wonders for a ‘man’s game’ riddled with cynicism and greed
How to stop an asteroid hitting Earth: Would people co-operate to face down a global peril?

How to stop an asteroid hitting Earth

Would people cooperate to face a global peril?
Just one day to find €1.6bn: Greece edges nearer euro exit

One day to find €1.6bn

Greece is edging inexorably towards an exit from the euro
New 'Iron Man' augmented reality technology could help surgeons and firefighters, say scientists

'Iron Man' augmented reality technology could become reality

Holographic projections would provide extra information on objects in a person's visual field in real time
Sugary drinks 'are killing 184,000 adults around the world every year'

Sugary drinks are killing 184,000 adults around the world every year

The drinks that should be eliminated from people's diets
Pride of Place: Historians map out untold LGBT histories of locations throughout UK

Historians map out untold LGBT histories

Public are being asked to help improve the map