A vertiginous drop in equity implied volatility has made capital-protected products with 100% participation in the underlying possible for the first time since the equity markets started falling in early 2000. Bankers expect a flurry of activity because waning vol is coinciding with demand from retail investors for growth products.
The recent development of 100% participation structures has broken a psychological barrier for investors and has enormous marketing potential, said Onno Vriesman , director in the exotic structuring group at Deutsche Bank in London .
Investors are interested in products with a five-year maturity, 100% participation and a capital guarantee, added Lode Roose , product developer at KBC Asset Management in Brussels . KBC may consider offering its first sterling-denominated product to capture the opportunity, but is not able to offer such structures in the euro-zone at the moment because interest rates are too low.
Arom Pathammavong , v.p. in equity derivatives structuring at Citigroup in London, said, "The fact that now there is the possibility to go for short-dated notes means that these products are more interesting." Several structurers agreed that the retail sector has an increasing appetite for growth products and the combination of a short maturity and high participation likely will whet investors' appetites.
The capital-protected notes are structured by purchasing a zero-coupon bond and using the remaining principal, plus the stock dividends, to purchase an equity call option. The longer the maturity of the notes, the more money is available to purchase the option. Investors, however, are more interested in short-dated notes. Martin Bertsche , head of the financial engineering group at JPMorgan in London, explained that dealers are able to structure the products because low volatility has reduced option premiums. "With low volatility you can put together products that you couldn't create two years ago."
Implied volatility is currently at an eight-year low and the market is full of theories as to the reasons. Alla Goudzinskaya , equity strategist at ABN AMRO , observed that implied vol is low because perceived risk is also low.
Since year end, implied volatility on the Standard & Poor's 500 has dropped to a low of 14.5% from 18% before the holiday.
