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Derivatives

Bear Stearns Adds Equity Downside Cushion

Bear Stearns is adding extra downside protection for investors in structured equity products, which contain options that allow the underlying assets to be put back to investors when the underlying falls.

Bear Stearns is adding extra downside protection for investors in structured equity products, which contain options that allow the underlying assets to be put back to investors when the underlying falls. The twist--known as a down and in or airbag--requires that the underlying fall to a lower level than the put strike before it is exercisable, reducing the chance of the assets being put back to the investor.

Joseph Chan, managing director, said with the Hang Seng, the Nikkei and other Asian exchanges showing reinvigoration over the last six months, those levels are higher giving clients increased concern over downside if markets fall. Many of the firm's previous structures are being auto-called, paying profits to the clients, who then begin to rollover their capital into new positions to maintain exposure to the market.

With the airbag protection clients will not be hit with the put option at expiry if the strike price is reached, as long as the value of the underlying never falls to another lower level during the product's lifespan. For example, the underlying on an option with a strike of 90% of the value at issue would not be delivered at expiry unless it reaches a lower level of 80% at some point during its life, and even then it is not exercised at expiry unless the underlying is still below the strike price. This 80% does not act as a barrier, however, and the underlying could potentially be put at a lower level if the underlying continues to fall until expiry, just as it could also return to a level above the strike price and not be exercised at all.

Chan said the feature is being added to a number of structures, including callable accrual, standard auto-call and leveraged upside participation.

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