37 lines
2.9 KiB
Plaintext
37 lines
2.9 KiB
Plaintext
Chapter 32: Structured Products 595
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having your money in the bank. Forgetting structured products for a moment, this
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means that stocks in general would have to increase in value by over 40% during the
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seven-year period just for your performance to beat that of a bank account.
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In this sense, the cost of the imbedded call option in the structured product is
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this lost interest - 4.19 or so. That seems like a fairly expensive option, but if you con
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sider that it's a seven-year option, it doesn't seem quite so expensive. In fact, one
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could calculate the implied volatility of such a call and compare it to the current
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options on the index in question.
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In this case, with the stock at 10, the strike at 10, no dividends, a 5% interest
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rate, and seven years until expiration, the implied volatility of a call that costs $4.19
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is 28.1 %. Call options on the S&P 500 index are rarely that expensive. So you can see
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that you are paying "something" for this call option, even if it is in the form of lost
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interest rather than an up-front cost.
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As an aside, it is also unlikely that the underwriter of the structured product
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actually paid that high an implied volatility for the call that was purchased; but he is
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asking you to pay that amount. This is where his underwriting profit comes from.
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The above example assumed that the holder of the structured product is par
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ticipating in 100% of the upside gain of the underlying index over its striking price.
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If that is not the case, then an adjustment has to be made when computing the price
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of the imbedded option. In fact, one must compute what value of the index, at matu
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rity, would result in the cash value being equal to the "money in the bank" calcula
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tion above. Then calculate the imbedded call price, using that value of the index. In
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that way, the true value of the imbedded call can be found.
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You might ask, "Why not just divide the 'money in the bank' formula by the par
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ticipation rate?" That would be okay if the participation were always stated as a per
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centage of the striking price, but sometimes it is not, as we will see when we look at
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the more complicated examples. Further examples of structured products in this
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chapter demonstrate this method of computing the cost of the imbedded call.
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PRICE BEHAVIOR PRIOR TO MATURITY
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The structured product cannot normally be "exercised" by the holder until it
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matures. That is, the cash surrender value is only applicable at maturity. At any other
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time during the life of the product, one can compute the cash surrender value, but
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he cannot actually attain it. What you can attain, prior to maturity, is the market price,
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since structured products trade freely on the exchange where they are listed. In actu
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al fact, the products generally trade at a slight discount to their theoretical cash sur
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render value. This is akin to a closed-end mutual fund selling at a discount to net |