35 lines
2.5 KiB
Plaintext
35 lines
2.5 KiB
Plaintext
604 Part V: Index Options and Futures
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Or, thinking in the alternative, if the index triples, then the structured product
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(before adjustment factor) would be triple its initial price, or 30. Then 30 x 91.25%
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= 27.375.
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This example begins to demonstrate just how onerous the adjustment factor is.
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Notice that if the underlying doubles, you don't make "double" less 8.75% (the
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adjustment factor). No, you make "double" times the adjustment factor - 17.5% -
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less than double. In the case of tripling, you make 3 x 8.75%, or 26.25%, less than
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triple (i.e., the structured product is worth 27.375, not 30, so the percentage increase
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was 173. 75%, not 200% - a difference of 26.25%, stated in terms of the initial invest
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ment). How can that be? It is a result of the adjustment factor being applied to the
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$SPX price before your profit (cash settlement value) is computed.
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THE BREAK-EVEN FINAL INDEX VALUE
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Before discussing the adjustment factor in more detail, one more point should be
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made: The owner of the structured product doesn't get back anything more than the
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base value unless the underlying has increased by at least a fixed amount at maturi
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ty. In others words, the underlying must appreciate to a price large enough that the
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final price times the adjustment factor is greater than the striking price of the struc
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tured product. We'll call this price the break-even final index value.
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An example will demonstrate this concept.
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Example: As in the preceding example, suppose that the striking price of the struc
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tured product is 1,100 and the adjustment factor is 8.75%. At what price would the
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final cash settlement value be something greater than the base value of 10? That
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price can be solved for with the following simple equation:
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Break-even final index value = Striking price/ (1- Adjustment factor)
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= 1,100 / (0.9125) = 1,205.48.
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Generally speaking, the underlying index must increase in value by a specific
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amount just to break even. In this case that amount is:
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1 / (1 - Adjustment factor) = 1 / 0.9175 = 1.0959
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In other words, the underlying index must increase in value by more than 9.5%
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by maturity just to overcome the weight of the adjustment factor. If the index increas
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es by a lesser amount, then the structured product holder will merely receive back
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his base value (10) at maturity.
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The previous examples all show that the adjustment factor is not a trivial thing.
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At first glance, one might not realize just how burdensome it is. After all, one might |