UBS Warburg has created a capital guaranteed note on the DAX and Euro Stoxx 50 that offers more upside potential than traditional structured products and is being aimed at investors who are turning bullish on equity markets. The one-year certificates will offer higher participation than most guaranteed notes, but in turn also have the potential for a 100% wipeout, said Martin Boldt-Christmas, equity derivatives analyst in London.
Traditional structured notes that use zero-coupon bonds to achieve the capital guarantee can only offer lowly levels of upside participation because, in the current low interest rate environment, zeros are relatively expensive and hence eat up most of the principal. Conversely, UBS is pitching notes with a capital guarantee limited to 20%, Boldt-Christmas explained. "If you have 20% participation, that's not a lot of fun; this is a bit more explosive than a traditional guaranteed product." He continued "if you want equity exposure, you don't just want a little exposure." The fund will sell out-of-the-money puts and buy-out-of-the-money calls to gain exposure to equities and offset the cost.
For example, Boldt-Christmas said if the underlying security gains 100%, then investors would receive 70% of the upside through the note, while investors in a traditional capital guaranteed structure would only gain 50%. However, the UBS structure would begin to under perform traditional guaranteed products if the underlying were to fall by more than 20% in one year and investors could lose up to 100% of their capital. Meanwhile, investors in traditional guaranteed products would not incur any losses in that event. "But given these markets, there has been quite a lot of interest; timing-wise, I think it works out very good," Boldt-Christmas said. The notes are intended for retail investors. Boldt-Christmas declined to estimate how much the bank will sell.