After the toughest trading year he has ever experienced, Citi's global head of equity trading expects higher-margin derivatives to help the Wall Street stalwart steer a path through a similarly rocky 2012.

A slide in cash volumes as international investors and buy-side houses fled the European market has prompted a rash of layoffs across the industry, underpinning Mike Pringle's goal to reshape the unit away from a lower-margin, cash-centric model.

Pringle told Reuters the firm was gradually moving some staff from cash into derivatives and Delta 1 products such as exchange-traded funds (ETF) as it looked to increase sales of them to traditionally cash-oriented clients.

Citi has announced plans to cut 4,500 jobs globally. Some of those cuts came in equities, where net revenues fell 14 percent year-over-year to $2.5 billion (1.5 billion pounds) in the first nine months of 2011.

Pringle maintains the division's headline numbers do not tell the whole story. Year-on-year we have grown our client-facing revenues. I believe that commission levels at most of our competitors are down over the same period.

Ultimately, Pringle said, the push into derivatives could result in the current 50/50 revenue split between derivatives and Delta 1 trading on one side and cash-market trading on the other moving to 70/30 in favour of derivatives.

The higher margins on offer would likely underpin the move. Margins on electronic cash trading can be as thin as 3-5 basis points, while ETFs are typically around 10-15 basis points.

Delta refers to the degree of correlation between a derivative and its underlying asset, with 1 the highest correlation and a level traders aim to maintain.

The strategy has a colourful history, however, with two of the most high-profile trading losses of recent times -- Societe Generale's 4.9 billion euro loss through Jerome Kerviel, and UBS's $2.3 billion hit from Kweku Adoboli in September -- both coming via the banks' Delta 1 desks.

The attraction is clear because, across the industry, cash equities businesses make little profit after bonuses and other incentives are paid. Banks have been able to more than make for up the shortfall in futures and Delta 1 in recent years.

Citi's equity business is focusing on providing a wider array of products and services to a core group of top clients, a model Pringle, who has 15 years in equities, suspects others will follow.

Three years out, Pringle said Citi would target emerging market strength, look to have an amazing electronic offering and still maintain its presence in core activities such as its M&A business.

What everyone on the Street does now is everything for everyone. That's a dangerous proposition, as you don't get paid for that.


Traditional long-only institutions were becoming much savvier with derivatives, Pringle said, driving an estimated increase in derivatives volume of 5 to 10 percent in 2011.

With the market lacking direction, funds sell call options to maximise yield. Sovereign wealth funds, meanwhile, also invest in a bullish way, by selling puts to buy stocks.

ETFs are also a particularly attractive bet for funds keen to retain as much of their returns as possible. ETFs can cost as little as 10-15 basis points to access an index, while some external managers can charge as much as 1-2 percent.

The use of equity futures as a proxy hedge for other asset classes was also helping drive derivative volumes, especially those for the Standard & Poor's 500 <.SPX>, Pringle said.

Macro hedge funds, credit funds and others were using futures to hedge, which had helped blow the industry stock cash-to-futures ratio out to a high of 6-1 this year.

Selling equity futures was the fastest, cleanest way to put on a hedge, and S&P 500 futures was the place of last resort to express a bearish bet on the global outlook, Pringle said.


Pringle expects more of the same in 2012.

I'm not that optimistic about (cash) volumes returning in 2012. They will be directly correlated to the euro crisis, Pringle said. U.S. investors are cash rich, but not interested in putting any of that money into Europe right now.

In addition to the macro uncertainty, the scaling back of banks' proprietary trading and the exit of a lot of key quantitative investors were adding to the low volumes, he added.

And those volumes are never coming back, never. So the only volume driver to the market is classic long-only investment, and that doesn't come back until this whole euro zone problem is on a clear path to resolution.

Unless there is a significant breakthrough in the euro zone debt crisis, Pringle fears the market could test previous lows, although, putting it to one side, European stocks could potentially rise 15-20 percent from current levels, he added.

Uncertainty over the wall of national debt to be refinanced in 2012 would likely weigh on equity markets, however.

As a result, equities are likely to remain technically volatile, especially as forward risk, through volatility and dividends, is being priced at a medium level... which I think is slightly complacent.

Pringle said equity volumes would remain light. The market would react positively to a resolution of the European debt crisis, but people are going to be cautious as global growth has to reflect this at some point down the road, he said.

(Editing by Douwe Miedema and Helen Massy-Beresford)