Financial Markets Atlas: Hedge Funds (US)

FX Prime Brokerage Give-Ups for a Macro Fund

A macro fund trades currency with many dealers but faces only its prime broker: each dealer gives the trade up to the PB through Traiana at execution, the PB books it to the fund at the same rate plus a fee, margins the net book, reports it and settles the dealer legs in CLS. The fund gets the best price from the street and one counterparty, one margin call and one settlement. Global macro and CTA strategies run on this.

• FX prime brokerage: the fund signs an FX prime brokerage agreement with its PB and the PB signs give-up agreements (the ISDA master give-up) with each executing dealer, setting limits per fund; the dealer’s credit risk is on the PB, the fund’s risk is on the PB; the PB charges per million and earns the financing and the margin; the large banks and a few specialists provide it.
• Strategies: global macro (discretionary views on currencies, rates and equity indices, traded in forwards, options and futures), CTAs and systematic macro (FX forwards and futures across dozens of pairs, rolled monthly), currency carry and emerging market strategies; all need many dealers for price and one counterparty for operations.
• Operations: Traiana Harmony is the give-up and matching network; the PB’s portal shows the fund its positions, margin and fees; the fund reconciles the PB’s record to its OMS and PMS daily; settlement is net with the PB in the PB account, which also holds the margin; the trade repository reporting falls on the PB.
• Risk and margin: the PB margins the net book under its FX prime brokerage terms (initial margin by currency pair and tenor, daily variation), often under a portfolio margin model with the rest of the prime relationship; the fund’s treasury watches the margin across its primes and the concentration of its FX risk at one PB.

A Macro Option Structure Under the ISDA, With Uncleared Margin

A macro fund buys a currency option spread from a dealer under its own ISDA, pays the premium from its custodian, and runs the position bilaterally: variation margin under the CSA every day and, because the fund is above the uncleared margin threshold, initial margin computed with SIMM and posted to segregated accounts both ways. At expiry the dealer pays the cash settlement. Global macro volatility and event trades run on this.

• Bilateral versus prime: a hedge fund with its own ISDAs trades directly with dealers and manages its own collateral; a fund trading through an FX PB has one ISDA and one margin; large funds do both, since some products (exotic options, long-dated trades) stay outside the PB arrangement and some dealers want the direct relationship.
• UMR for hedge funds: the largest funds (over USD 8 billion of uncleared notional across the manager’s funds) exchange two-way SIMM initial margin with each dealer; the custodial setup (an account control agreement per dealer at the fund’s custodian, or triparty), the daily IM calculation and reconciliation on Acadia and the threshold monitoring are a treasury function; many funds stay under the threshold by clearing or by keeping notional down.
• Strategies: discretionary macro (event trades, rates and FX volatility), systematic macro, and volatility arbitrage funds that trade the vol surface against realized volatility; FX options are also the hedge for the fund’s own share classes in other currencies.
• Valuation: the administrator values options independently (vendor surfaces, dealer quotes), compares with the manager’s marks and reports differences; the valuation policy and the pricing committee settle disputes; investors’ due diligence asks exactly how.

An Emerging Markets NDF Carry Position

An emerging markets macro fund sells dollars against the real in a non-deliverable forward to earn the rate differential in the forward points, through its FX prime broker or bilaterally, margined at EM levels. At the fixing the contract settles in dollars for the difference; no real ever moves. Carry, EM macro and systematic currency strategies run on this.

• Carry and EM macro: the fund earns the forward points (the rate differential) and loses if the currency falls more than the points; positions are sized by volatility and liquidity; the strategies range from discretionary EM macro to systematic carry baskets across a dozen currencies, often with local bonds and CDS alongside (see the Fixed Income and Rates groups).
• NDF mechanics: BRL, INR, KRW, TWD, IDR, PHP and others settle in USD against a published fixing because the currency cannot be delivered offshore; the fixing source and time are in the confirmation; the market trades on multi-dealer platforms and by voice; dealers hedge in the onshore market where they can.
• Clearing and reporting: NDFs are not mandated for clearing in the US; LCH ForexClear clears them voluntarily (dealers for capital reasons, some funds through their FCMs); the dealer or the PB reports to the SDR; the fund’s FX PB gives one margin and one settlement across dealers.
• Risk: EM margin at the PB is a multiple of G10 margin and rises in stress; liquidity in a sell-off (2013, 2020) means the fund may not be able to cut at the price it sees; the fund’s risk reports show EM by country and the stress tests apply historical gaps.

The Treasury Cash-Futures Basis Trade, Financed in Repo

A relative value fund buys Treasury notes, sells the futures against them and finances the notes in repo with a small haircut, capturing the basis at high leverage. The cash trade and the repo are sponsored into FICC, the notes settle through the custodian and go straight out to the repo dealer, the futures are margined at the FCM, and the repo is rolled every day. The financing, not the basis, is where the trade can break.

• The strategy: relative value and multi-strategy funds run the basis at scale (hundreds of billions of gross positions across the industry in 2023 to 2025); the profit is the basis minus the financing cost; the risks are the repo funding (haircuts, rolls, dealer balance sheet at quarter ends) and the futures variation margin in a shock (March 2020), which the Fed, the SEC and the FSB have all studied.
• Clearing: the SEC’s Treasury clearing mandate brings the fund’s cash Treasury trades (December 2026) and its repo (June 2027) into FICC through sponsored membership; the sponsoring dealer guarantees the fund and posts the FICC margin, charging the fund for it; the margin and the netting change the trade’s economics and its funding risk.
• Operations: the fund’s custodian receives the notes and delivers them to the repo dealer the same day (or the triparty agent allocates them); the repo collateral is margined daily under the MRA; the overnight leg is re-traded every morning by the fund’s repo desk; the FCM statement carries the futures; the treasury system shows the financing cost, the haircut capital and the maturities by dealer.
• Related trades in the same machinery: the swap spread trade (Treasury versus a cleared swap, see Rates), the CDS-bond basis (see Fixed Income), the MBS basis (see Securitized), cross-country bond basis trades, and the futures roll trade; all are financing-dependent relative value.

Cash and Collateral Across Primes, FCMs and the Custodian

The fund’s treasury function starts every day from the prime brokers’, the FCMs’ and the custodian’s statements, builds one view of cash, collateral and margin, moves cash and positions between primes, sweeps excess cash to the custodian, funds the FCM margin, negotiates financing terms and lock-ups, optimizes what is posted where, and reports the counterparty exposure. Every strategy on the page depends on it.

• Why the treasury function exists: a fund’s long positions are financed by its primes (margin loans against the securities), its shorts by the primes’ stock loan, its derivatives by margin at the FCMs and the dealers; the fund’s own cash is spread across all of them; after Lehman (2008) funds learned that assets at a prime can be frozen, so excess cash and unencumbered securities moved to custodians and funds added a second or third prime.
• Financing economics: the prime charges a spread over the benchmark on the debit balance, pays a rate on credit balances, and sets the stock loan rebate by name; term financing and lock-ups cost more; the primes’ own funding (rehypothecation of the fund’s margin securities, internalization of longs against shorts) sets what they can offer; the treasury head negotiates with each prime quarterly and moves business to the better terms.
• Operations: a treasury system (Hazeltree, the primes’ portals, or in-house) aggregates the statements, computes margin and excess, runs the optimizer and produces the wires; cash movements have dual control and the administrator’s reconciliation; the FCM margin is funded by the custodian delivering bills or wiring cash before the FCM’s cut-off.
• Reporting: Form PF reports the fund’s counterparty exposures, financing and liquidity to the SEC; investors’ due diligence covers the primes, the cash policy and the leverage; the multi-strategy platforms run treasury centrally for all their pods and treat financing as a competitive advantage.

Swap Spread and Curve Trades Cleared Through the FCM

A rates relative value fund pays fixed on a cleared swap against a repo-financed Treasury and runs a curve steepener in swaps, all traded on a SEF and cleared at LCH through the fund’s FCM. The CCP nets every swap in the book, the FCM calls the margin, the custodian moves it, and the position is managed in DV01 terms with any dealer. Relative value, macro and multi-strategy rates books run on this.

• Rates relative value: swap spreads, curve and butterfly trades, basis between futures and swaps, cross-currency basis, inflation breakevens; the positions are large in notional and small in risk per unit, financed through repo and margined at the CCP; the strategy’s returns depend on financing and on the CCP’s margin model as much as on the view.
• Clearing through an FCM: the fund signs a cleared derivatives addendum with each FCM, the SEF checks the FCM’s limit before the quotes, the CCP novates within minutes, and the FCM guarantees the fund to the CCP and calls the margin; the fund can port its positions to another FCM if one fails; LSOC segregation protects the fund’s margin from the FCM’s other clients.
• Margin: the CCP’s initial margin model (a historical VaR over a lookback with a margin period of risk) nets offsetting positions in the same account; a fund’s portfolio of spread and curve trades benefits from the netting; the FCM’s add-on and the variation margin in cash each day are the running costs; the 2022 gilt episode showed what VM calls do to leveraged rates books.
• Global macro uses the same machinery for directional swaps and swaptions; CTAs use rate futures instead (see CTA Trend Following); the Treasury leg of a spread trade is the basis trade’s machinery (see Money Markets).

A Rates Volatility Position in Swaptions, Bilateral Under UMR

A volatility fund sells a swaption straddle to a dealer under its ISDA, hedges the delta with cleared swaps and trades the gamma until expiry. The trade is bilateral: variation margin under the CSA and SIMM initial margin both ways at segregated custodians. At expiry the in-the-money leg is exercised into a cleared swap at the fund’s FCM. Volatility arbitrage and macro vol books run on this.

• Volatility strategies: selling or buying rates, FX and equity volatility against realized, relative value across the vol surface and across asset classes, tail hedging funds that buy convexity; the P&L is implied minus realized minus the cost of hedging, and the risk is the gap (a rate shock) and the margin it brings.
• Bilateral trading for a fund: an ISDA and CSA per dealer, the UMR initial margin program for in-scope funds (SIMM, custodial accounts, Acadia reconciliation), the dispute process for marks, and the novation market for moving a position between dealers; many funds clear swaptions voluntarily at CME or LCH to avoid the IM and to net with their swaps.
• Exercise and settlement: since the 2021 ISDA definitions, USD swaptions settle physically into a cleared swap or in cash against the CCP’s settlement rate; the exercised swap appears at the fund’s FCM and is margined there; the operations team watches expiry dates and the exercise notices.
• Valuation: swaptions are valued off the vol cube (expiry by tenor by strike); the administrator uses vendor cubes and dealer quotes, the manager its own model; the tolerance and the pricing committee are what investors’ operational due diligence asks about.

CTA Trend Following in Rate Futures Across Several Brokers

A managed futures fund’s model turns short bonds and the desk executes across three brokers and three exchanges, each trade given up to the fund’s clearing FCMs, which hold the margin in bills and settle the variation daily in three currencies. The custodian holds the rest of the fund in bills, the treasury funds the margin, and the roll calendar and the position limits run the life of the book. Rates are one of sixty markets in the same machinery.

• Managed futures and CTAs: systematic trend following and its variants (multi-horizon, carry, mean reversion) across 50 to 150 futures markets, registered with the CFTC as commodity pool operators and trading advisers; the largest run tens of billions; the strategy’s machinery is futures execution, give-ups, FCM clearing, margin in bills and the roll.
• Execution: CTAs trade at scheduled times (opens, closes, VWAP windows) through executing brokers’ algorithms, measure slippage against the model’s price and allocate flow to brokers on that basis; the give-up to the FCMs under EGUS agreements separates execution from clearing; two FCMs by region cover the time zones and the counterparty risk.
• Margin and cash: futures need only initial margin (a few percent of notional), so the fund holds most of its assets in Treasury bills at the custodian and delivers them to the FCMs as margin; variation margin in each currency is funded daily; the non-USD variation creates an FX exposure the fund hedges; the CCPs’ portfolio margining across correlated contracts lowers the requirement.
• Position limits and rolls: CFTC and exchange limits apply per contract month and are aggregated across the manager’s accounts; the roll schedule avoids first notice and delivery (a CTA never takes delivery); cash-settled contracts (SOFR, equity indices) expire at the settlement price; the operations team’s calendar is the control.

Credit Long/Short With Cash Bonds and CDS

A credit fund buys a bond it likes, hedges the market with index protection cleared through its FCM and shorts a weak name with bilateral single-name protection under its ISDA. The bond settles into the prime broker account and is financed there against a haircut; the three margins (PB, FCM, CSA) run in parallel; coupons, rolls and credit events run through DTC, the FCM and the Trade Information Warehouse. Credit long/short, event-driven credit and multi-strategy credit books run on this.

• Credit hedge fund strategies: long/short credit (fundamental, by issuer), event-driven credit (new issues, tenders, M&A), structured credit, distressed, and the CDS-bond basis trade (long bond plus protection when the basis is negative, financed at the PB); the multi-strategy platforms run all of them as pods on central financing.
• Financing bonds at a prime broker: the PB lends against the bond at a haircut by rating and liquidity (investment grade 5 to 15%, high yield 15 to 30%, distressed more or not at all), charges a spread over SOFR, and can rehypothecate the bond within the US limit; short bonds are borrowed through the PB’s fixed income lending desk at a fee; the fund’s treasury compares financing across its primes.
• CDS for a fund: index CDS mandated to SEFs and cleared at ICE through the FCM like a swap; single names bilateral under the ISDA (voluntary clearing exists), with VM and, for in-scope funds, SIMM initial margin; the TIW runs the coupons and the credit events; a fund holding the bond and the protection goes through the ISDA auction with a choice of physical or cash settlement.
• Valuation: corporate bonds at evaluated prices, with dealer quotes for illiquid lines and the pricing committee for the rest; CDS from Markit; the administrator’s independent prices and the manager’s marks are reconciled monthly; investors ask about the share of the book priced by dealer quotes or models.

Distressed Debt Through a Restructuring

A distressed fund buys the secured notes and the term loan of a company about to file, joins the creditor group under an NDA, finances almost nothing, negotiates and votes the plan, and receives new equity and a new note through a DTC exchange on the effective date. The information wall, the valuation memo and the fund’s own liquidity terms (gates, side pockets, lock-ups) are the operating constraints of the strategy. Distressed, special situations and event-driven credit funds run on this.

• The strategy: buying debt of companies in or near bankruptcy below recovery value and driving or riding the restructuring; the ad hoc group, the restructuring support agreement, the DIP loan, the plan vote and the exchange are the sequence; the fund may end up controlling the company (loan-to-own) with the governance and filing consequences; liability management exercises outside court (uptiers, drop-downs) are the current variant.
• Information: joining a creditor group means signing an NDA and going restricted; the fund’s compliance maintains the restricted list and the wall between its public-side and private-side desks; trading while in possession of MNPI is the risk; big boy letters are used when restricted holders sell to each other.
• Operations: defaulted bonds settle at DTC flat (no accrued) and fail often; loans and claims settle by assignment with court transfer notices; the PB finances little; claims are filed by the bar date; the plan exchange is a DTC corporate action with elections; the new securities need CUSIPs and often start unlisted; the fund’s operations team runs a calendar of court deadlines.
• Fund terms: distressed funds use longer lock-ups, quarterly or annual redemptions with notice, gates and side pockets for positions that cannot be valued or sold; the administrator values from dealer quotes and the manager’s memos under a documented policy; Form PF reports the illiquid share and investors’ due diligence tests the valuation governance.

Capital Structure Arbitrage Across Bonds, CDS and Equity

A fund trades the mispricing between an issuer’s credit and its equity: protection bought under the ISDA against shares bought through the prime broker, sized by a structural model. The two legs settle, finance and margin on different rails (MarkitSERV and the CSA for the CDS, DTC and the PB for the shares) and the fund manages them as one position until an event or a convergence closes the trade. Capital structure, convertible and event-driven funds run on this.

• The strategy: relative value between the instruments of one issuer (senior and subordinated bonds, loans, CDS, convertibles, preferred and common equity, options) using a structural model of the firm (Merton-type) or the arbitrage relationships between them; the event-driven variants trade tenders, exchanges and recapitalizations; convertible arbitrage is the oldest form (see Equities).
• Rails: single-name CDS is a security-based swap (SEC) confirmed on MarkitSERV, recorded in the TIW and reported to an SBSDR by the dealer; clearing at ICE is voluntary and available for the liquid names; the equity and the bonds sit at the prime broker; the fund’s OTC prime arrangement with the PB can bring the CDS under the PB’s margin so that the hedge is recognized.
• Margin recognition: a PB’s portfolio margin recognizes offsets only among positions it holds; a CDS with another dealer is margined separately under the CSA; the fund pays margin on both legs unless it consolidates them at one counterparty, which is the treasury team’s trade-off between margin efficiency and concentration.
• Risk: jump-to-default (the credit event that pays the CDS and zeros the equity, or the reverse when a takeover tightens the spread and lifts the stock), model risk in the hedge ratio, and the liquidity of single-name CDS; the risk team runs the trade as a package with scenario P&L by leg.

The Agency MBS Basis: Specified Pools Against TBAs, With Dollar Rolls

A structured products fund buys specified pools with a prepayment story, sells TBAs against them and finances the pools in repo, earning the pay-up as the pools prepay slower than the TBA cohort, plus the roll when the dollar roll trades special. The pools settle on Fedwire Securities and go out in repo; the TBAs are margined under the MSFTA with each dealer; the whole book turns over every month. Mortgage relative value and multi-strategy fixed income books run on this.

• The strategy: relative value in agency mortgages (specified pools versus TBA, coupon swaps, the roll, agency CMOs and IOs/POs against TBA hedges), financed in repo and hedged with Treasuries, swaps and TBAs; the risks are prepayment model error, the roll turning cheap, repo financing and the margin on the TBA short in a rally (the 2020 unwind hit these books).
• Rails: specified pools settle on Fedwire Securities through the PB or the custodian; TBAs are forwards margined under the MSFTA (FINRA 4210) with each dealer, netted at FICC MBSD on the dealer’s side; the fund repos the pools with the PB or dealers under an MRA; the monthly SIFMA calendar (notification, settlement by class) and the agency factor updates drive the operations.
• Dollar rolls: selling the TBA for this month and buying it for next (or the reverse) at the drop; when the drop implies a financing rate below repo the roll is special: the holder of a long TBA position earns it by rolling, and a fund short TBA pays it when it rolls; the Fed’s and the banks’ demand set the specialness; the roll book is often the most profitable part of the basis.
• Valuation and leverage: pools priced from vendor models plus pay-ups from dealer quotes; the TBA short at the screen; the administrator reconciles factors between the agency, the PB and the fund; the gross book is many times the equity and Form PF reports it; investors see the strategy’s leverage and financing terms in the due diligence.

Structured Credit: CLO Tranches Bought on BWICs

A structured credit fund buys a CLO’s BB tranche and equity on a bid-wanted list after modeling the deal in Intex, finances the rated tranche at the prime broker and holds the equity unfinanced, surveils the deal quarterly through the trustee reports, collects the waterfall through DTC, votes on a refinancing and exits on its own BWIC. Structured credit, multi-strategy credit and some distressed books run on this.

• The strategy: CLO mezzanine and equity, CMBS and non-agency RMBS tranches, ABS, risk transfer securities (bank SRTs), and the financing of all of them; returns from carry and from the convexity of tranches bought below par; the risks are credit (the collateral), structure (the tests and the waterfall), liquidity (lists and appointments) and financing (haircuts that widen in stress, March 2020).
• BWICs: bids wanted in competition are the secondary market for structured paper: a seller circulates a list through a dealer with a bid time, bidders submit, the cover (second-best bid) is disclosed; dealers also hold inventory and show offerings; TRACE disseminates 144A structured trades with caps and delays; the fund’s trader lives on the daily BWIC calendar.
• Operations: 144A CUSIPs at DTC settled through the PB on T+2 or T+3; the deal set up in the security master with the Intex model, the payment calendar and the factor; trustee reports collected and parsed; distributions reconciled to the waterfall; the PB’s financing marks reconciled to the fund’s; the equity’s votes and refinancing documents handled by the fund’s legal team.
• Valuation: mezzanine from vendor evaluated prices and dealer quotes; equity from the model with dealer color; the administrator applies the valuation policy and the pricing committee rules on exceptions; the share of the NAV priced by model is a due diligence question and an audit item.

A Long/Short Pair With a Short Sale Through the Prime Broker

The core of long/short equity: a long bought through one executing broker and a short sold through another after a locate from the prime broker, both given up to the PB, which settles them at DTC, borrows the shares for the short from a lender, finances the long and holds the short proceeds. Borrow fees, rebates, recalls and buy-ins are the life of the short; portfolio margin on the pair is the leverage.

• Long/short equity: the largest hedge fund strategy by number of funds; fundamental stock picking long and short, run at 100 to 200% gross with a net exposure that defines the style (market neutral, low net, long biased); the sector specialists and the multi-strategy platforms’ equity pods trade the same way; quantitative long/short uses the same rails at higher turnover (see Statistical Arbitrage).
• The short machinery: Regulation SHO requires a locate before every short sale and the close-out of fails (Rule 204); the prime broker’s stock loan desk sources borrows from its own clients’ margin securities (rehypothecation), from agent lenders and from other brokers; the fee by name (general collateral to hard to borrow), the rebate on the collateral and the recall risk are the economics; crowded shorts (2021) are where borrow fees and buy-ins hurt.
• Financing and margin: the long side is a margin loan (Reg T, then portfolio margin for qualifying funds), the short side generates proceeds the PB holds; the PB nets the two and the fund’s leverage is set by the margin; the PB rehypothecates up to 140% of the debit; a second PB is where part of the book goes to spread the counterparty risk.
• Reporting: 13F quarterly for the longs (over USD 100 million), 13f-2 monthly gross short position reporting since 2025, 13D and 13G at 5%, Section 16 at 10%; the executing brokers report to CAT; the PB’s statement is the record the administrator and the auditors use.

Synthetic Prime: Total Return Swaps With the Prime Broker

The fund takes a short and a leveraged long through total return swaps with its prime broker rather than holding and borrowing the shares. The PB executes the hedge in the market (or wraps another broker’s execution), passes the stock return plus or minus a financing spread, margins the swap book with the rest of the prime account, resets daily or monthly, passes dividends through and reports the swaps as security-based swaps. Long/short, event-driven and quantitative funds use it for markets they are not set up in, for leverage and for the balance sheet it saves them.

• Why synthetic: access to markets the fund is not set up to settle in (Europe, Asia, emerging markets), leverage on the PB’s balance sheet, shorts without the fund doing the locate, lower balance sheet usage for the fund and sometimes a different tax or disclosure treatment; the costs are the financing spread, the PB’s right to terminate and the concentration of risk at one counterparty.
• Give-ins: the fund executes with any broker and the PB wraps the execution into a swap at that price (the broker gives the trade in to the PB), so that best execution and the swap financing are separate decisions; the PB’s delta-one desk otherwise executes the hedge itself and the fund sees the all-in price.
• Reporting and the Archegos lesson: equity swaps are security-based swaps reported by the dealer to an SBSDR; Rule 10B-1 position reporting and the 13F treatment of swap exposure are the SEC’s response to a family office holding concentrated swap positions across several primes with no view of the whole; primes now share more data and margin swap books on concentration.
• Operations: a master confirmation for the swap program, daily or monthly resets, the PB’s swap margin inside the portfolio margin, dividend and corporate action terms in the ISDA definitions, and the administrator’s reconciliation to the PB’s swap statement; a fund with several primes consolidates its synthetic exposure in its own books, since no prime sees the others.

Merger Arbitrage on a Stock and Cash Deal

An event-driven fund buys the target of an announced acquisition and shorts the acquirer in the deal ratio, capturing the spread between the target’s price and the offer value if the deal closes. The prime broker settles both legs, borrows the acquirer shares, finances the pair under portfolio margin and processes the closing as a DTC exchange, after which the received shares cover the short. Merger arbitrage, event-driven and multi-strategy funds run on this.

• Event-driven strategies: merger arbitrage (announced deals), special situations (spin-offs, restructurings, index changes, activism), event-driven credit; the return is the spread times the probability of completion minus the loss on a break; diversification across deals and sizing by break risk are the discipline; the strategy’s returns rise with rates (the spread is partly a short-term rate).
• Rails: the long and the short are ordinary equity trades through executing brokers, given up to the PB; the acquirer borrow is the scarce resource (crowded deals see borrow fees rise and recalls); the closing is a mandatory corporate action at DTC with the exchange terms, fractional shares in cash and the tax treatment; options on the target and the acquirer are the alternative hedge and the break protection.
• Regulation: HSR filings for large positions in the target, 13D within 5 days if over 5% with an activist intent (an arbitrageur usually files a 13G), Section 16 at 10%; the fund’s compliance tracks the thresholds per deal; insider trading around deals is the enforcement risk, and the wall between the fund’s event desk and any private-side involvement is the control.
• Margin: a PB’s portfolio margin recognizes the deal hedge and charges a reduced requirement, with a deal-break stress; a diversified deal book runs at 2 to 4 times gross on that basis; the PB’s terms on arbitrage books and the borrow on acquirers are negotiated as part of the prime relationship.

Convertible Arbitrage: Bond Long, Stock Short at the Delta

A convertible arbitrage fund buys a convertible bond from a dealer’s desk and shorts the stock at the model’s delta through an executing broker, both settling at the prime broker, which finances the bond, borrows the stock and margins the package. The fund trades the gamma by rebalancing the short as the stock moves, carries the coupon against the borrow fee, and ends by converting or selling. Convertible arbitrage, capital structure and multi-strategy funds run on this.

• The strategy: buy convertibles whose embedded option is cheap relative to the stock’s volatility, hedge the equity (delta), often the credit (CDS or asset swap) and the rates (futures), and earn the gamma and the carry; the hedge fund community is the main buyer of convertible new issues, which price cheap to the model for that reason; 2008 (financing withdrawn, shorts banned) and 2020 are the stress episodes.
• Rails: the bond settles at DTC through the PB like a corporate bond (TRACE from the dealer); conversion runs through DTC’s conversion agent on the fund’s instruction; the stock short is the long/short machinery (locate, borrow, rebate, recall); the CDS leg, if used, is the credit machinery under the ISDA; the PB margins the package under portfolio margin and finances the bond at a haircut.
• Terms the operations team tracks: coupon dates, the conversion ratio and its adjustments for dividends and corporate actions, call and put dates, make-whole provisions on a takeover, the hedge fund’s own borrow arrangements with the issuer’s lead bank on a new issue (the lead often arranges borrow for the arbitrageurs to make the deal work).
• Valuation: convertibles priced from vendor evaluated prices and dealer quotes, with the fund’s model (implied volatility, credit spread, borrow cost) for the exceptions; the administrator values independently and the pricing committee handles illiquid lines; the position is reported by leg and as a delta-adjusted package.

Statistical Arbitrage With Direct Market Access

A quantitative fund’s models send hundreds of thousands of orders a day straight to the exchanges through a broker’s direct market access or sponsored access, with the broker’s risk checks in the path, and the day nets to small positions the prime broker finances and borrows overnight. The infrastructure (co-location, feeds, the simulator, the risk controls) is the strategy; the operations reconcile net positions, not trades. Statistical arbitrage, quantitative long/short and some multi-strategy pods run on this.

• Quantitative equity strategies: statistical arbitrage (short-horizon, high turnover), factor and quantitative long/short (longer horizon, lower turnover, the same rails as fundamental long/short at scale), and the multi-strategy platforms’ quant pods; the edge is in signals, execution and infrastructure, and the capacity of each signal limits assets.
• Market access: direct market access through a broker’s infrastructure or sponsored access under the broker’s membership, in both cases with the broker’s pre-trade risk controls required by Rule 15c3-5 (credit and capital limits, erroneous order checks); co-location at the exchanges’ data centers and direct feeds are the fund’s own cost; the broker reports all orders to CAT.
• Economics of the rails: exchange fees and rebates under maker-taker and taker-maker schedules, the broker’s per-share commission, the PB’s financing and borrow on the overnight book, the data and co-location costs; the SEC’s 2024 changes to tick sizes and access fees and the ongoing debate on rebates affect the strategy directly.
• Operations: a standing locate list from the PB for the short universe each morning, net settlement through the executing broker, a reconciliation of net positions and of the broker’s trade count against the fund’s system, corporate action exclusions, and the kill switch and incident process; the SEC’s Knight Capital case (2012) is the reference for what fails.

Equity Volatility: Variance Swaps and Listed Options

A volatility fund sells index variance to a dealer under its ISDA and buys single-stock straddles on the options exchanges, cleared at the OCC through its prime broker, hedging the deltas in stocks through the PB and in index futures through the FCM. Three margins run in parallel (the PB’s options margin, the CSA on the swap, the FCM on the futures) and expiry settles each leg on its own rails. Volatility arbitrage, dispersion and tail-risk funds run on this.

• Volatility strategies in equities: dispersion (index versus single-stock volatility), relative value across the surface and across expiries, volatility selling for carry, tail-risk funds that buy convexity, and the systematic volatility premium funds; the instruments are listed options (cleared at the OCC), variance and volatility swaps (bilateral), VIX futures and options (at the CFE and the OCC).
• Rails: listed options clear at the OCC through the fund’s prime broker as clearing member, with the PB’s margin; variance swaps are security-based swaps under the ISDA, reported by the dealer, margined under the CSA and UMR; the delta hedges are stocks at the PB and futures at the FCM; three statements and three margin calls for one strategy.
• Expiry: American-style single-stock options can be assigned early (dividends); index options settle in cash at the opening or closing level; the variance swap settles against realized variance from the daily closes over the period; the operations calendar carries every expiry and the exercise decisions.
• Valuation and risk: options at exchange marks, variance swaps from the dealer’s and the fund’s models with the administrator’s independent check; the risk report shows vega by expiry, gamma, the correlation exposure and the P&L under volatility and correlation shocks; February 2018 (the short volatility unwind) is the reference stress.

A Discretionary Energy Spread in Futures and Options on Futures

A commodities fund trades the refining margin as a crack spread in NYMEX futures and adds options on futures, through an energy broker, given up to its FCM, which margins the spread with the clearing house’s spread credit in Treasury bills from the custodian. The expiry calendar is the hard constraint, since the contracts deliver physically and the fund never does. Discretionary commodity, energy and multi-strategy commodity books run on this.