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Subject:  Re: Structured products? Date:  2/11/2013  8:12 PM
Author:  globalist2013 Number:  34779 of 36082

Just for the sake of argument, let’s take a look at the bet being offered. The underwriter seems to be betting that the Euro Stoxx 50 index is going down. Each month that it trades at less than 80% of its value when the structured product is rolled out, the buyer of a bond tied to the index would receive no monthly payment. Otherwise, he gets a monthly coupon (whose value is 7% ann. for the first five years).

There is an ETF that tracks the index, as well as options chains on that EFT, and probably futures for the index, as well as options on those futures contracts. So there’s lots of ways to recreate a “home brew” version of the bet. But let’s take the simplest case, that of making an unleveraged, directional bet on the underlying itself. And let’s benchmark the index (represented by FEZ) against a comparable US counterpart (such as SPY or DIA).

Clearly, the EuroStoxx50 (aka, FEZ) is more volatile than DIA or SPY, which means it’s more tradable. So let’s drop down to a shorter time frame. If the would-be buyer of the bond had done nothing more than go long on a cross of Price over a 20-period SMA, he/she could have pulled in 14%, right? or twice the yearly coupon. Similar money could have been made going short. If those bets had been leveraged (through options, futures, or options on futures), then even better money could have been made *provided* the bets had gotten both the direction *and* the timing correct. But isn’t that also true for the bond buyer? He/she has to get the direction and timing correct, or else they’ve merely made an interest-free loan to the bond issuers.

If you buy the structured product, you think you are excused from doing your homework. But you can bet that your counter-party has done theirs, and you can bet that you will lose any bet you make with a more well-informed counter-party. However, da, da, you could become your own counter-party by putting together a set of trading rules that would have as its goal a minimum return of 7% per year. And having built that tool, you could apply it more widely than to just the single index.

That’s why buying ready-made products is so harmful. It induces laziness and sloppy thinking. You become so bedazzled by the upsides that you forget about the downsides. But if you make the effort to see how/where they intend to profit and do a knock-off, then you gain both knowledge and, possibly, some fat profits.
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