The vanilla call (or put) is the root of all optional products, from warrants to very complex structured products. The principle hasn’t changed since its invention more than 3 decades ago. In 2007, a famous french bank reinvented this fundamental pillar, giving birth to a new generation of derivatives.
"What is it?"
As with many leading ideas, the principle of the timer call is remarkably simple: instead of fixing the maturity and letting the volatility float, we fix the volatility and let the maturity float. The Timer Call also allows the pricing of call and put options on underlyings that were previously excluded from the options industry since their implied volatility is very difficult to price.
"How does it work?"
In a traditional vanilla call, the maturity is fixed and the life time decreases linearly until 0. The idea of the Timer Call is to fix a budget of variance / volatility, decreasing until 0. The maturity of the Timer Call depends on the time period of the budget consumption.
Example on HSBC stock
"What are the benefits?"
* Suppression of implied volatility’s extra cost in call options: Call prices depend on the implied volatility level, usually higher than realised volatility, representing the risk premium, seen as an extra cost of call prices. The Timer Call avoids this extra cost.
* Systematic market timing: The Timer Call systematically optimises market timing. If volatility increases, the call terminates earlier, with the investor realising a profit. If the vol doesn’t rise, the call simply takes more time to reach maturity. In other words, time becomes extractable as an investable asset class (like volatility became an asset class with the invention of the vol swap).
Risk - Risk Management | Derivatives | Structured ProductsJuly 2007, page 6 "SG CIB Launches timer options" by Nick Sawyer
The Banker - July 2007, page 12 "Special supplement - Equity Derivatives"
* [http://www.socgen.com Société Générale's website]
* [http://www.sgcib.com Société Générale Corporate & Investment Banking (SG CIB)]
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