Very small, almost irrelevant. If you search long and hard I'm sure you can find an approximate number but it's so small that it would be a waste of time.
A "letter of credit" ? I think you must be mistaking instruments here. A letter of credit is a payment instrument that necessarily implies 3 parties (like a check). Are you thinking of "credit lines" between financial institutions ? Which OTC instruments do not involve such flows ? Both the EFS & EFP that you have mentioned are not financial instruments but rather operations on financial instruments. A swap involves cash flows just like a futures contract.
Both credit lines and letters of credit are used for OTC trading. Credit lines for better names, letters of credit (aka cash collateral) for lesser names. Correct, EFS and EFP are operational but both can be used in certain (not all) situations to get around the issue that scriabinop23 was asking about. In theory yes, a swap does involve swaping cash flows, but in practice (assuming both parties have "good credit) this only occurs at settlement, so with a swap you don't face the daily margin/cash flow issues that you do w/ futures.
Sorry, but I can not concur that a letter of credit can be considered as a cash collateral as there is, by definition, big credit risk on letters of credit. A massive haircut would have to be applied to a letter of credit that would make it impractical (if you are interested in looking into letters of credit : http://en.wikipedia.org/wiki/Letter_of_credit ) I have never seen a swap contract that only implies transfer of cash at settlement (I practice law and am specialised in financial market law). Usualy what happens is that the parties decide on a threshold level (often 50 000, 75 000 or 100 000 USD in many of the ISDA contracts that I have negociated), and there is no effective cash flows until the threshold is touched (ie when the movement on the underlying causes a move worth at least the threshold amount in the swap). So, yes, there is not necessarily a daily cash flow, but there is a cashflow when the amount to be transfered is at least as much as the specified threshiold, but witholding all cashflows until setlement is not at all common practice, nor would I ever accept such a proposition because of the credit risk it would imply.
Correct, it can happen more than just at settlement (assuming the market moves beyond the credit threshold) but I was just trying to make the point that people often trade OTC to avoid the day to day cash flow swings w/ futures...I agree regarding thresholds, etc but I wasn't going to get into the fine details here as they're irrelvant to 99% of the people on this board. Regarding the LOC, I guess we'll just have to agree to disagree as I have a LOC for a nat gas producer (to be used as collateral for swaps, above and beyond the initial threshold) sitting on my desk and the terms are significantly different and better than you implied. Just curious, do you have experience in energy or are you speaking more about fixed income and the like? Part of the reason for my asking is that crude and nat gas producers use LOCs quite often for hedging related transactions.
Petrotrader, Don't get me wrong, a LOC is entirely possible to use as collateral (the proof being on your desk ) it is just very marginal and, personaly, I have never seen it done. Maybe it is common practice on the commercial side of the energy markets ? My experience on the markets is kind of 2 fold ... I used to be an FX trader before I went through law school, then, during & after law school, I continued to work in FX & energies for my own account, but started practicing law in the hedge fund industry, so, no I do not have any experience on the commercial side of energies, just the hedge fund side. You trade for energy producers/distributors ?
It's common for producers, most others operate under standard ISDAs, NAESBs, etc. Interesting background...Given your experience is mainly on the funds sides your views make sense. Yeah, I trade on behalf of producers, distributors, large end users, etc.
Just a couple points froma scan of the last few pages, 1)The cleared product traded on ICE is a nymex look a like, volumetricaly it trades more than the entire front month contract at the NYMEX. (1 ICE Lot = 2500mmbtu = 7.75 Nymex contracts) 2)The letters of credit or bilateral agreements are mainly for utilities/producers who are trading basis and want to deliver/hedge. It was common place pre Enron and has been phased out since cleared prods have become the norm. 3)You are utterly insane if you start trading a ratio crude natty spread. That has blown up more people/firms than you can imagine. 4)The corelation between the basis and the futures is loose at best and not something you should trade as a little side trade. Look at Chicago City Gate v. NYMEX in 2000 when a force majeur was declared in Chicago. That being said it is great trade with proper capital
Thats the dilemma I'm finding -- its not easy to trade if you like averaging in, especially lately. By the time you are in prime position (unless your sense of timing is impeccable), its easy to become overleveraged. For me its not a question of capitalization (my actual account leverage is next to zero), but the fact that I don't like seeing my account swing so wildly on one trade with a equivilent of a few physicals open (i trade both qg and ng ...). I dream of a 1000mmbtu 'micro' contract -- that would be perfect for my average in style. Imagine the liquidity on that thing too...
Hello Artis, Letters of credit are not bilateral agreements (just as a cheque is not a bilateral agreement). A letter of credit is a payment instrument that involves 3 parties and that results in transfering the beneficiary of a debt (otherwise said, the person of the creditor changes). "Mainly used for utilities/producers" ? May be you are takling specificaly about the energy markets, but letters of credit are commonly used il all sorts of commerce. Insane to trade crude/nat gas spread ? ... yes, I would tend to agree as the correlation is quite low. Did anyone here mention that he/she was trading such a spread ?