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Eqonomics

Structured Products Explained: How to Use a Reverse Convertible

April 1, 2022

Adam Wise

Structured Products Explained: How to Use a Reverse Convertible

In this Eqonomics, we will showcase a simple and popular product linked to the price of BTC: The Reverse Convertible.

A structured product is a pre-packaged investment with a defined risk-return profile and is linked to an underlying asset’s performance. Unlike buying a stock, bond, or individual crypto, structured products have a fixed maturity, and they may also include an early conditional redemption.

Structured products can provide exposure to crypto in a more accessible format, such as a fund or a note bought and settled in USD. Investors can obtain exposure to Bitcoin performance without having to own or store any.

What is a reverse convertible?

Designed for yield, a Reverse Convertible offers investors an attractive fixed coupon. Although capital is at risk, a Reverse Convertible provides limited mitigation to adverse BTC performance.

The redemption of capital at maturity is dependent on the BTC/USD price, and clients will suffer a loss if the price at maturity is below a pre-determined level.

Pricing example

Maturity: 30 September 2022

Coupon: 10% (20% p.a.)

Strike: $40,000 (80% of initial level)

BTC/USD Price: $50,000

Investors purchase the product for $100 at inception.

At maturity, there are two outcomes:

  • If BTC/USD is above $40,000 (80% of its initial price), investors will receive their entire initial investment of $100.
  • If BTC/USD is below $40,000 they will suffer a capital loss. For example, if BTC/USD is $30,000, investors would receive 75% of their initial capital. Redemption is calculated as $100 x $30,000 / $40,000 = $75.

In all cases, a coupon of $10 is paid.

Downside protection is provided for up to a -20% move in BTC/USD price at maturity.

Pricing is indicative only and not a solicitation of investment.

Determining the payout

The product’s risk/reward profile follows the logic of an investor selling a put option.

  • Put options are more expensive when implied volatility is higher. Higher volatility, higher coupon.
  • The strike is a key factor when pricing a reverse convertible. A strike closer to the current spot price leads to a higher probability of capital loss at maturity. Higher strike, higher coupon.
  • Options increase in price as a function of their expiry. Longer maturity, higher coupon.

As for all investments: the higher the perceived risk, the higher the potential reward.

Suitability for you?

Structured products are historically a favorite of private banking clients as they receive yield for a recognized risk.

The products are customizable to match an investor’s risk/reward tolerance and can provide single exposure to more complex trades. They can also be structured to act as a hedge or replace traditional cash/fixed-income investments.

If you are interested in learning more about structured products at EQONEX, please get in touch.


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