Reviewed by Oct 05, 2020| Updated on
A prop-shop is a trading company that deploys its own resources to generate profits from trading. 'Prop' is the short form of proprietary. Prop shops employ a number of trading strategies for assets that range from simple liquid assets such as stocks and bonds to sophisticated instruments such as collateralized debt obligations (CDO), derivatives, and commodity futures. They are also interested in big macro bets and arbitrage strategies.
Prop shops may go long, may go short, or may do both. Traders usually do buy and sell, but algorithmic trading is important for a growing number of prop shops.
Prop shops are composed of people who invest their own money. If these owners want to run a tight ship, they are going to be doing the trade themselves. If they want to scale up, the owners of the prop shop will hire traders to conduct specified plans or lose them to trade freely on their own.
Those taken on board will contribute their own capital as an entry fee and will be subject to risk caps for trading. A prop shop shares gains from sales between the company and the dealer if any. Trading in proprietary shops is a high risk, high reward.
Until the Volcker Rule was implemented, proprietary trading desks could be found at investment banks that operated with large chunks of bank money. Such prop desks often received disproportionate amounts of money for their owners, and sometimes fared poorly.
Morgan Stanley's prop department, for example, lost $9 billion from mortgage trading in 2007. The Volcker Rule either removed prop desks on Wall Street or severely curtailed them. Many of these gun-slinger traders who earned millions of dollars in bonuses despite losing billions for bank shareholders entered or founded prop shops. Nobody knows if a dealer loses his own money at a gas shop.