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Author: brewer12345 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 744602  
Subject: Re: Equity-Indexed Annuities Date: 7/14/2005 8:37 AM
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Daryll:

If you want to more-or-less replicate the product:

- buy a long term treasury or high grade corporate bond
- Every year you take most of the coupon and buy an equity index call option at the money.
- At the end of the year, sell the index option for whatever you can get for it.
- Reinvest the proceeds in a long term bond and repeat steps 1 through 3.

Assuming a $100k investment in this strategy:

- buy $100k 10 year treasury yielding 4.16%.
- Use $2660 to buy an S&P500 index call option. This might be SPYFS, which costs $5.40 per hundred shares. You would get options on 492.6 shares. This equates to options on about $60k.

If the index goes up, you get the appreciation on $60k plus $1500 (the part of the coupon you ddn't use to buy options).

A few caveats:

- This example ignores commissions.
- Note that the options only cover $60k notional. To get the full $100k covered, the insurer would sell an offsetting call option that effectively caps your upside, but delivers 100% of the rise between the at the money pricce and the cap. You could do it that way if you choose.
- Every year, the amout of index options you can buy with your coupon will change as the VIX changes. Insurers adjust for this too, so you wouldn't be getting a free ride with the annuity.
- You don't get dividends either with this strategy or the annuity.

FYI, the commission on this product to the salesperson is generally 8 to 10% of the amount invested, paid up front. Goess whose hide that gets taken out of?

I just saved you $8 or $10k, my friend. Worth way more than the cost of an annual TMF membership ;}.
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