Structured Products, or equity-linked structured products - the
name alone should give pause: structured for whom? And with a name
like this -
JPMorgan Chase & Co. Contingent Absolute Return
Autocallable Optimization Securities
- would you wonder what these are?
These have been created as fixed income instruments for
yield-seeking individual investors. And, surprisingly, you don't
have to be an "
" to buy them.
Although I have attended trader conferences that discussed
structured products, have spoken with individuals and brokers who
deal with them, have observed the growth of these for over seven
years, and know that there are big sales commissions involved, I
still didn't understand them until I was swayed into buying one
involving Apple (
) common stock, and then I read a Wall Street Journal article
describing how the Apple related products cratered.
These securities are essentially bonds that can turn into stocks
of other companies. The prospectus for this particular security
states "Contingent Absolute Return Autocallable Optimization
Securities are unsecured and unsubordinated debt securities issued
by JPMorgan Chase & Co. (
) ("JPMorgan Chase") (each, a "Security" and collectively, the
"Securities") linked to the performance of the common stock of a
specific company (the "Underlying Stock")."
Structured products usually pay high interest, often monthly,
for a period of a year or less. If the stock the products are tied
to rises or stays close to its price at the time the bonds were
issued, investors get all their money back, and interest, when the
bonds come due.
But if the stock falls more than 20% or so, the bonds can morph
into shares of the fallen stock. And, they are illiquid. Investors
must hold these to maturity.
The firms structuring these and selling these, not surprisingly,
In 2012, Apple shares soared and firms such as
) sold more than $722 million of these equity-linked instruments
according to a Securities and Exchange Commission analysis by
Securities Litigation and Consulting Group, a research firm. 450 of
these were linked to Apple alone. (Most large brokerage firms
structure and sell these products).
Now, because of the drop in Apple common stock, these products
are 20% to 30% underwater.
Investors, including me, should have asked this question: Why
would banks offer 10% interest when most one year debt is paying
The answer - and this is what I couldn't find earlier - is that
the investment banks get something in return. In the case of the
Apple-linked products, it gives them a cheap way of hedging or
betting that Apple stock would go down. Now, they can dump the
fallen stock on investors who thought they were buying a
conservative bond. And, if the investor doesn't want the stock he
will sell it again.
In short, the deck is stacked against anyone buying these
In my case, Apple must climb about 30% for me to get all my
money back. (I don't mind owning Apple and will probably keep it
when it's put to me, and I did buy these with my eyes partly open
as what is turning out to be an expensive experiment). Just like a
"naked" put option, committing to buy the stock I don't yet own
after it falls in price.
Investors could have just done the puts, but you need to sign a
special trading agreement and be pre-approved. But when the option
is embedded within a structured product, the selling broker doesn't
need to jump these hurdles.
FINRA is said to be
at these products and how they are sold to retail investors. And,
because the conversions to equity aren't trades there is no trade
confirmation. Interestingly, FINRA groups these securities within
section of market data).
As the Wall Street Journal article states "there is no such
thing as high yield and low risk. Complexity always favors the
seller, and the house always wins."
I am long [[AAPL]]. I wrote this article myself, and it expresses
my own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
With Treasuries, It's Not About The Interest