Mechanics of a structured product - help structured, discount, product, current, offered

Elliotbay

A friend approached me today to evaluate a structured product offered by his advisor. I am not well versed with SP mechanics so I hope that some of you could perhaps share your insight as to the inner workings of this product. (risks etc)

2 yr term

Choose any 2 stocks that you would not mind owning at 30-40 % discount to current trading levels. If I am not mistaken there is a volatility criterion.

You get paid 1%/month till the end of the the term (2 years) unless the stock trades at pre -determined price (i.e. 30-40% level below current value). In this case, you own the stock and the contract is finished.

I think there is probably more to it but in any case any insight will be helpful.

TIA.



Edited 1 time(s). Last edit at Wednesday, September 21, 2011 at 08:14PM by C3Po.

eerenyuan

这东西里面哪里有barrier? 明明就是个out-of-money的put，稍微复杂一点点的地方估计是这东西是同时卖两个put，但是其中任何一份执行了另外一份就失效------帖子里面没这些写，但我记得有那种产品，为了让卖option的人觉得价格更诱人，故意做出这种介于一份option和两份option之间的东西------因为两个都是价外的，当两只股票的相关性不是特别强的时候，本质上和两份期权没太大差别。由此造成的一种错觉是：只卖了一份期权，却得到了超出一份期权的价格。当然，因为他实际上不是一开始付对价，而是中间支付利息，也可以认为这是一个类似CDS或者保险的东西，1%的东西可以当成是保费。

另外，这东西只算是exotic option吧，结构相对还是简单，离structured product还是有点距离的。

ruchita

C3Po Wrote:
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> Where does the investment firm make it's money. Only from the fee?

Is there an upfront payment of the principal, which you get back at expiration? If so, the firm makes money from the interest on that principal. The derivative package that they sell you will generally be less valuable than the interest on the principal. This will be in addition to whatever commissions of fees that they charge.

zephyranalyst

nvm



Edited 1 time(s). Last edit at Thursday, September 22, 2011 at 09:30AM by ohai.

tikfed

C3Po Wrote:
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> Where does the investment firm make it's money. Only from the fee?

There are sometimes games around how payments/coupons/dividends and compounding/schedules are done - be sure you've taken a close look and understand it.



Edited 1 time(s). Last edit at Thursday, September 22, 2011 at 09:14AM by LPoulin133.

himanshumh

BangBusDriver Wrote:
-------------------------------------------------------
> Basically it's a barrier option with some sort of
> equity swap component fixed to it.
>
> Do you end up owing it if it goes below 40% level
> or stays above 60% level?
>
> Both trades are possible. In both the cases,
> they'll make money with fees, volatility,
> correlation and a swap with someone else if there
> is some sort of upfront payment which should be
> there. There must be a volatility criteria, this
> 1% they are paying is essentially coming from
> structuring volatility, and 1% is quite high, so
> there must be something to lever up the trade from.

your friend's end.
>
> From their side, they'll go long the volatility,
> and depending on what happens at barrier.. they'll
> go long/short the correlation as well, they might
> long/short deep in the money put/call depending on
> what happens at barrier, and they might as well
> initiate a total return swap with someone else,
> and finally they'll keep on constantly delta
> hedging.

@bangbusdriver. Thanks for your input.

Not quite clear as to how the equity swap would fit into this. Could you elaborate.

If the stock price stays above the barrier then you continue to get paid on a monthly basis. Once it reaches the barrier, the contract is null & void and you end up owning the shares at their lower values.

In terms of money, my friend is not borrowing money to invest. When you refer to structuring volatility, are you referring to the VIX or the vol/co relations of the stocks to each other/vix.

Oh, just one more thing, can this not be achieved by just selling front month puts and pocketing the premium which is higher than the barrier premiums.

Thanks for you help. very helpful and enlightening

AnalystAlan

it should be ATM strike down and in barrier at 30-40% of current price Put option that investor sells within the structured product

morebeans

Basically it's a barrier option with some sort of equity swap component fixed to it.

Do you end up owing it if it goes below 40% level or stays above 60% level?

Both trades are possible. In both the cases, they'll make money with fees, volatility, correlation and a swap with someone else if there is some sort of upfront payment which should be there. There must be a volatility criteria, this 1% they are paying is essentially coming from structuring volatility, and 1% is quite high, so there must be something to lever up the trade from your friend's end.

From their side, they'll go long the volatility, and depending on what happens at barrier.. they'll go long/short the correlation as well, they might long/short deep in the money put/call depending on what happens at barrier, and they might as well initiate a total return swap with someone else, and finally they'll keep on constantly delta hedging.

cfalevel2011

Basically it's a barrier option with some sort of equity swap component fixed to it.

Do you end up owing it if it goes below 40% level or stays above 60% level?

Both trades are possible. In both the cases, they'll make money with fees, volatility, correlation and a swap with someone else if there is some sort of upfront payment which should be there. There must be a volatility criteria, this 1% they are paying is essentially coming from structuring volatility, and 1% is quite high, so there must be something to lever up the trade from your friend's end.

From their side, they'll go long the volatility, and depending on what happens at barrier.. they'll go long/short the correlation as well, they might long/short deep in the money put/call depending on what happens at barrier, and they might as well initiate a total return swap with someone else, and finally they'll keep on constantly delta hedging.

ba736

.



Edited 1 time(s). Last edit at Thursday, September 22, 2011 at 03:47AM by BangBusDriver.