New issues of Japanese barrier knock-in equity-linked products are down by at least 50% this month as a downward lurch in the Nikkei 225 in March left many retail investors deep underwater. One equity derivatives trader estimated JPY100 billion (USD800 million) of Nikkei-linked notes were knocked-in in March, when the market traded down to 11,200. The index closed at 13,973.03 Thursday
In a typical transaction, investors purchased an ELN with an embedded long knock-in call and short knock-in put, either on the Nikkei index, or, more commonly, on a single stock, explained Marc Saffon, head of financial engineering at Societe Generale Securities in Tokyo. As long as the underlying trades above the trigger on the knock-in, the investor receives an above market return. However, if the underlying trades below the trigger, the call and the put are knocked-in and the value of the ELN then becomes directly linked to the underlying asset, he continued.
"Many clients were upset because their notes were near maturity and the knock-in event presented them with a principal loss of anywhere from 15% to 30%," said another equity derivatives trader.
Carlo Georg, managing director and head of trading, Asia, atKBC Financial Products in Tokyo, said many of the ELNs were sold some 12 months ago when the Nikkei was in the 15-20,000 range. Many of the barriers were set at the 13,000 level, since few investors thought the Nikkei would fall below this level.
Despite the setback, several traders believe single-stock ELN investors stand to recoup their losses with a rebound in Japan's equity market. "People are skeptical on the Nikkei rally from 12,000 to 14,000 and they are waiting to see if the government can really carry out structural reforms after the upper-house election this summer," cautioned Chea Srun, head of derivatives trading, at Dresdner Kleinwort Wasserstein. "If this does indeed happen, we expect renewed interest by the summer," adds another trader.
J.P. Morgan, BNP Paribas,Lehman Brothers and UBS Warburg were also active in the trades, said market players. An official at UBS confirmed its presence. Officials at the other firms declined comment.