Abbey National Financial Products plans to sell embedded knock-in digital puts as part of a high-income product it is offering. The retail product gives investors exposure to the 10 largest FTSE 100 stocks through a reverse convertible, according to Andrew Brogden, senior trader in London.
There are two types of note. The first offers a return of 6% for five years and a 100% capital guarantee. The second offers a return of 8% for five years but with only 70% of the capital guaranteed.
The put knocks-in if the shares fall below 50% of their value. The investor would lose the maximum amount if seven or more shares halve in value and stay there until maturity.
New Direction Finance will sell the product, but ANFP earns a premium for structuring the trade. Brogden said, "We try to lock in the value by hedging as much as possible." He added, however, "The correlation between the individual stocks is our biggest risk factor and is almost impossible to hedge." To hedge the risk, ANFP needs to sell the digital barrier puts. Since the five-year market is illiquid, it will likely have to sell shorter dated puts and monitor the risk.
