Origin
BICs Markets are a market structure advocated in the Book BICs 4 Derivatives Volume I: Theory under the pen name Obi-Wan Yoda and based on the Basis Instrument Contract theory and in the international patent filing publication number WO2003107137 .
Operations
In such a market,
- A price taker submit a request for a derivatives contract that is expressed as a function of the realized values of the different underlyings upon which the derivatives contract depend.
- Using an iterative BICs Decomposition formula, the derivatives contract is broken down to the exact or best replicating set of BICs.
- The trading system then select for each component among the different market makers the one(s) providing the most competitive price.Combining those price plus possible a service mark-up is the price provided to the price taker.
Benefits
Such a market ensures that derivatives contracts are priced at the most efficient cost, that hedging costs are minimized and known beforehand or as soon as possible.
Such a system further reduces hedging costs by eliminating the need for frequent re-hedging of risky positions.
This stands in contrast with the Greeks based dynamic hedging approach derived from the Black Scholes Merton theory that advocates continuous re-balancing of trading portfolios based on the Panglossian view of a world where markets have infinite liquidity, no transaction costs exists and trade is done continuously.
The side figure further illustrates the system.
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