Tuesday, July 24, 2012

Structured products for nervous investors

Structured products for retail investors are back. For those who have some extra money, there are always structured CDs (like this one from Goldman). And then we have exchange traded structured notes for everyone else. Like this note called eUnit (ticker symbol ETUA) from Eaton Vance.
WSJ: - It is the eternal investor dilemma: How to invest in the stock market, without the risk?

Eaton Vance Corp. thinks it has a solution. The Boston-based company, with $192 billion in assets under management, earlier this year launched an unusual structured product with returns that are tied to the Standard & Poor's 500-stock index. Experts say it could be the first of similar products to follow.

Called an eUnit Trust, the investment limits the amount of losses an investor can sustain, but also caps the earnings during the lifetime of the investment—a period of two years.
How does Eaton Vance put one of these together? Actually it's quite simple. They take investors' money and do 4 things with it:
1. Buy 2-year treasuries.
2. Buy a 2-year in-the-money call on the S&P500 index.
3. To reduce the cost of the purchased call, they sell an out-of-the money call on the S&P500.
4. And of course charge 75bp per year

The timing is good because implied volatility is relatively cheap. Here is what the payout looks like.

eUnits payout structure

Below is the performance so far (underperforming the S&P500). Because of movements in implied volatility and the note trading at premium/discount to assets, one needs to hold it to maturity in order to get the full benefit of the payout structure.

eUnits vs. S&P500

So far there isn't much liquidity in these notes (maybe 1,500 shares per day). The product can certainly be replicated in a brokerage account that permits buying and shorting options. But one would need to put on size to do better than 75bp per year. That's why if this works out for Eaton Vance, there will be more products like this in the market.

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