38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
Cl,apter 32: Structured Produds 601
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Now, a rate of return of 2.43% is rather paltry considering that the risk-free
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T•bill rate was more than twice that amount. However, in this case, you own a call
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option on the stock market and get to earn 2.43% per year while you own the call. In
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other words, "they" are paying you to own a call option! That's a situation that
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doesn't arise too often in the world of listed options.
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If we introduce cash value into this computation, the discrepancy is even larg
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er. Using the $MID price of 177.59, the cash value can be computed as:
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Cash Value = 10 + 11.5 x (177.59/166.10 - 1) = 10.80
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Thus, with SIS trading at 8. 75 at that time, it was actually trading at a whopping
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19% discount to its cash value of 10.80. Even if the stock market declined, the guar
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antee price of 10 was still there to provide a minimal return.
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In actual practice, a structured product will not normally trade at a discount to its
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guarantee price while the cash value is higher than the guarantee price. There's only
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a narrow window in which that occurs.
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There have been times when the stock market has declined rather substantial
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ly while these products existed. We can observe the discounts at which they then
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traded to see just how they might actually behave on the downside if the stock mar
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ket declined after the initial offering date. Consider this rather typical example:
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Example: In 1997, Merrill Lynch offered a structured product whose underlying
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index was Japan's Nikkei index. At the time, the Nikkei was trading at 20,351, so that
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was the striking price. The participation rate was 140% of the increase of the Nikkei
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above 20,351 - a very favorable participation rate. This structured product, trading
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under the symbol JEM, was designed to mature in five years, on June 14, 2002.
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As it turned out, that was about the peak of the Japanese market. By October of
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1998, when markets worldwide were having difficulty dealing with the Russian debt
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crisis and the fallout from a major hedge fund in the U.S. going broke, the Nikkei had
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plummeted to 13,300. Thus, the Nikkei would have had to increase in price by just
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over 50% merely to get back to the striking price. Hence, it would not appear that
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JEM was ever going to be worth much more than its guarantee price of 10.
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Since we have actual price histories of JEM, we can review how the market
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place viewed the situation. In October 1998, JEM was actually trading at 8.75 - only
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1.25 points below its guarantee price. That discount equates to an annual com
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pounded rate of 3.64%. In other words, if one were to buy JEM at 8.75 and it
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matured at 10 about 40 months later, his return would have been 3.64% compound
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ed annually. That by itself is a rather paltry rate of return, but one must keep in mind
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that he also would own a call option on the Nikkei index, and that option has a 140%
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participation rate on the upside. |