Trading the ELF price
ELF prices will respond to news concerning;
- Catastrophes affecting the international reinsurance market
- Major entries and exits from the international reinsurance market.
- Developments in capital markets, but note that rising bond and equity prices may tend to depress prices in reinsurance markets. The reverse is also true.
IFEX ELFs can be used to trade price with little or no insurance risk if conducted outside of the relevant hurricane season.
Example of a price trade using actual historic bid and offer prices;
On July 31 the 2009 US Nationwide $20bn LTL was quoted as follows;
Lots Bid Offer Lots
20 21.00 25.90 75
On July 31, a Protection Seller sold 20 lots at 21.
In other words he risked $158,000 to gain $42,000 should a $20bn hurricane not occur in the period from July 31 2009 to December 31 2009.
However, prices were falling and he saw an opportunity to quickly close out his position at a profit by buying an identical contract at a price of 16 just 27 days later.
Rationale for the trade
The exceedance probability is believed to be about 14-15% in an ordinary season and the trade was concluded at an initial contract price of 21.
But two months of the season (June and July) had passed so the actual probability had fallen. This left the Protection Seller with significant basis points of value.
Soon after, the possibility of an EL Nino was announced which would tend to reduce the exceedance probability even more.
On August 4, Klotzbach and Gray of Colorado State University then predicted a quiet hurricane season – this reduced the exceedance probability for 2009 still further.
Buying Back the Contracts
The 20 lots sold on July 31 at 21 could have been bought back at 16 on August 27th.
This would have produced a gross profit of 500 basis points per lot or $10,000, then subject to total commission and exchange fees of $1,200, hence a net profit of $8,800 on the overall transaction for carrying the risk for 27 days.