Structured Products

[Ticker]

I noticed on the Fido site that they offer structured products. "Structured products offer investors the potential to earn returns tied to the performance of an index or basket of securities." Some look to be fairly expensive on the fee side, others less so. They limit both the downside and upside, and look tempting.

Has anyone had any experience that they can share with these types of products? Thanks in advance for the feedback.

 

[MBAustin]

I don't have any experience with this, and my general rule is not to invest in anything I don't understand, so good for you for asking. Hope someone out there can help.

 

[OldShooter]

... and my general rule is not to invest in anything I don't understand ...

+1

I am teaching an adult ed investing class. Here is a quotation from one of my slides for tonight's class:

"Rule of Thumb: The more complicated an investment product is, the more likely it is that it was designed to make money for the seller, not to make money for you."

 

[Dtail]

+1

I am teaching an adult ed investing class. Here is a quotation from one of my slides for tonight's class:

"Rule of Thumb: The more complicated an investment product is, the more likely it is that it was designed to make money for the seller, not to make money for you."

+1
Dealt with derivative valuations in j*b. Traders betting on weather, etc.

 

[FIRE'd@51]

Basically these products are a fixed income instrument where some or all of the interest is used to purchase an option or an option spread. A simple example is to buy a 12-month T-bill for 98 that will mature at 100. Use the 2% discount to buy as many one-year call options on the index as you can. If the index goes up, you will participate in the gain. If the index goes down, you get back your initial 100 when the T-bill matures. Generally, if you are familiar with options, you can create the structured product yourself more cheaply.

 

[gauss]

I noticed on the Fido site that they offer structured products. "Structured products offer investors the potential to earn returns tied to the performance of an index or basket of securities." Some look to be fairly expensive on the fee side, others less so. They limit both the downside and upside, and look tempting.

Has anyone had any experience that they can share with these types of products? Thanks in advance for the feedback.

These things are a marketers dream. I looked into something similar a decade ago. The thing that makes it work for them is that stock market returns on the upside do not come smoothly, but rather in large bursts. If you are maxed out every year or quarter you will miss out on the majority of the return.

There is no such thing as a free lunch, but a nontransparent product, on the other hand offers the sellers lots of spaces to hide details like this.

Proceed with extreme skepticism.
-gauss

 

[pb4uski]

Basically these products are a fixed income instrument where some or all of the interest is used to purchase an option or an option spread. A simple example is to buy a 12-month T-bill for 98 that will mature at 100. Use the 2% discount to buy as many one-year call options on the index as you can. If the index goes up, you will participate in the gain. If the index goes down, you get back your initial 100 when the T-bill matures. Generally, if you are familiar with options, you can create the structured product yourself more cheaply.

Exactly... often a collar since there is a participation rate and a maximum annual increase... depending on the cost of options the writer adjusts the participation rate and the maximum annual increase so that they can maintain their spread.

The "catch" often is that the crediting is based on changes in the index and ignore dividends... so let's say the participation rate is 100% and the index starts at 100 increases to 110 and then a dividend equal to 2 is paid and the index after the dividend is paid is 108 ... the credit on these products would be 8% because the index started at 100 and ended at 108... but an investor in the index actually had a 10% return... paid 100 and received 2 of dividends and 108 based on the ending value of the index.... so the investor in these structured products gets screwed out of the dividend.

 

[FIRE'd@51]

The "catch" often is that the crediting is based on changes in the index and ignore dividends... so let's say the participation rate is 100% and the index starts at 100 increases to 110 and then a dividend equal to 2 is paid and the index after the dividend is paid is 108 ... the credit on these products would be 8% because the index started at 100 and ended at 108... but an investor in the index actually had a 10% return... paid 100 and received 2 of dividends and 108 based on the ending value of the index.... so the investor in these structured products gets screwed out of the dividend.

I wouldn't say he gets "screwed". True he loses the dividend, but that's the cost of the built-in insurance. Remember he gets his 100 back if the market goes down, while the investor in the index faces a capital loss. In your example, the equivalent situation would be if the investor in the index bought a protective at-the-money put for 2.

 

[pb4uski]

Fair point.... I guess it all depends on the cost of an at-the-money put compared to a call.

 

[FIRE'd@51]

Fair point.... I guess it all depends on the cost of an at-the-money put compared to a call.

In this case, since the interest rate is 2% and the dividend yield is 2%, the 100 strike price is also the forward price so the put price and call price would be equal.

 

[Sunset]

I love it when folks explain obscure things like this, as it gives me a better ability to understand the complexity.

 

[bingybear]

I've seen them on the site. Never had anyone at Fidelity try to sell them to me.

Wait! If their not trying to sell it to me, it must be good for me!

 

[NW-Bound]

... A simple example is to buy a 12-month T-bill for 98 that will mature at 100. Use the 2% discount to buy as many one-year call options on the index as you can. If the index goes up, you will participate in the gain. If the index goes down, you get back your initial 100 when the T-bill matures. Generally, if you are familiar with options, you can create the structured product yourself more cheaply.

When I started to do options back in 2000, the above strategy occurred to me. I have never attended any talk nor paid any money to any coach, but discovered it myself. It's obvious, really, and seems quite reasonable.

So, I tried first on a small scale doing some LEAPs, not on the index but some stocks that I was sure would go above the strike prices I picked. It did not work out, and when the few thousands I allocated to these options were gone, I stopped.

Maybe I did not do it right, meaning selecting the options properly. But I lost interest in it, and did not experiment further.

 

[NW-Bound]

+1
Dealt with derivative valuations in j*b. Traders betting on weather, etc.

Weather? Derivatives on commodities, whose production yield is affected by rain, snow, drought, flood?

 

[OldShooter]

I love it when folks explain obscure things like this, as it gives me a better ability to understand the complexity.

Agreed. There is an active thread on "Modified Endowment Contracts" that is also of interest for the same reason.

Since I don't buy products I don't understand well this is strictly a spectator sport for me. But interesting nonetheless and a benefit of visiting the site.

 

[Ticker]

Many thanks for all of the replies. I knew that I had come to the right place for advice on this instrument.

 

[FIRE'd@51]

When I started to do options back in 2000, the above strategy occurred to me. I have never attended any talk nor paid any money to any coach, but discovered it myself. It's obvious, really, and seems quite reasonable.

So, I tried first on a small scale doing some LEAPs, not on the index but some stocks that I was sure would go above the strike prices I picked. It did not work out, and when the few thousands I allocated to these options were gone, I stopped.

Maybe I did not do it right, meaning selecting the options properly. But I lost interest in it, and did not experiment further.

This strategy has been around since the early 1980's. Back then it was called the 90-10 strategy because an investor would put 90% of his money in one-year Treasury bills (which were yielding 10% at that time) and 10% in call options. When the index options began to trade, it became more efficient to use those because the premiums were a lot less than those on a portfolio of options (since the volatility of a broad index was about half that of the average stock). IIRC, the first retail product was offered around 1986 by Chase Manhattan Bank who offered S&P 500 linked CD's of varying maturites.