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Mysterious Block Trade Patterns

In ever-increasing instances, numerous block trades transact (typically after-hours) for which settlement reveals no change in institutional ownership. Throughout 2011, the Thomson Reuters Utilities team recorded consistent blocks traded at the same time each month in various constituents of the S&P 500 Utilities Index. Most frequently, settlement reveals largest loans near the size of the block a few days before and after the trade-date. Even quarterly 13Fs do not uncover any “new” holders in the size of these inordinately large blocks.

This type of transaction occurs not just in U.S. markets, though in the U.S. these transactions predominantly revolve around ETFs and swaps, as in Europe the focus has been much more on dividend-related products.

The most frequent primary catalysts behind these transactions are: Equity Finance Trades or Dividend Capture Trades. These transactions are most frequently used by income driven funds and/or smaller institutional managers. An Equity Finance Trade, also considered a Delta One product, is a class of financial derivative that have no ‘optionality’ and as such have a delta of (or very close to) one. A delta of one means that for a given percentage move in the price of the underlying asset there will be a near identical move in the price of the derivative.

Delta One trading desks are either part of the equity finance or equity derivatives divisions of most major investment banks. They generate most revenue through a variety of strategies related to the various delta one products as well as related activities, such as dividend trading, equity financing and equity index arbitrage. These types of transactions really exploded in 2010, and the entity most frequently executing them are Gosha Trading, which began filing 13F holdings reports in 2011.

Dividend Capture Trades are primarily used for Tax Arbitrage for the upcoming dividend payment. Shareholders want the stock performance (Share Price + Dividend) without the tax burden of the dividend. The trade helps to lower leverage requirements, as lower margin call requirements on a swap then the equity ownership. Also, the trade maintains ownership of the shares after the swap is unwound.

The mechanics of the deal are as follows:

·    Institutional investor sells XYZ shares to a single brokerage firm

·    Brokerage firm sells the SWAP to the Institutional investor

·    Sale is typically done at LIBOR plus 2-5 basis points as a fee

·    Brokerage firm is not taxed for the cash dividend since this is considered day-to-day business

·    At end of holding period, broker buys back the SWAP and sells the XYZ shares back to the Institution

·    As a result of this deal, the SWAP and the sale of the XYZ shares are double counted which results in the increased volume

·    The trades are being executed primarily by Gosha Trading House

·    The block trades occur post-market at the closing price

·    These big block trades are considered “Cross Trades” which are non-biased trades, meaning neither bullish nor bearish for the stock

·    SEC requires that these trades are recorded on tape

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