Fine-tuning kick outs to maximise returnsSeptember 10, 2014 - 19:30
Most investors in kick out (autocallable) investments are expecting them to deliver a defined coupon and typically they expect this to happen before maturity.
The Cube Dual Defensive Boosted Kick-Out has been developed to maximize the return investors will receive if it kicks out at the second anniversary - the outcome which analysis shows to be most likely - while retaining a defensive trigger structure if the product does not kick out and lasts till its sixth anniversary. The product offers 26% if, on the second anniversary, the level of both the FTSE100 and Eurostoxx50 are above their initial index levels and there is a 75% final trigger at the sixth anniversary. For a full description of the product please click here.
Maximizing the annualised return at the point where the analysis that we have suggests that the product will mature seems like a sensible approach to us.
Figure 1; Probability of each event
Source investmentproductresearch.com, 7 September 2014
This chart shows the results of stress testing of the Dual Defensive Boosted Kick-Out, and also the results of simple historical back-testing; the analyses of both are done for us by investmentproductresearch.com (IPR).
The striking feature of this analysis is that the simulated probability of the product kicking out at the second anniversary is greater than the sum of the simulated probabilities of all of the other events that could happen.
Similarly, the simple back-test data shows that historically the product would have kicked out on the second anniversary on almost two-thirds of all the possible start dates we tested since 1993.
Including a dual trigger with different payouts at the sixth anniversary, and having a boosted initial coupon in return for a lower rate of increase at later potential kick out points means the returns are aligned with the likelihood of the potential kick outs, both in simulations and in backtests, as we show in Figure 2 below.
Figure 2, Annual Return and Payoff, source: investmentproductresearch.com, 7
Overall the IPR analysis suggests that there is an 88% chance of the maturity value being more than 100%, and the average annualised return in these cases is 9.7%. This is broadly in line with the back-test result
Cube Dual Defensive Boosted Kick-Out is a structured-capital-at-risk product (Scarp), and the final value will be less than 100% if the product does not kick out and the final value of either index is below 60% of the initial index level. The back-test shows that the product would have matured at less than 100% on 0.8% of the tested occasions. In these cases the average final value would have been 58.6%. IPR simulations suggest that there is a 7% chance that the final value will be less than 100%, and the average maturity value in these cases would be 48%. The IPR stress test is more conservative than the historic back-test.
David has been involved in equity derivatives, equity structuring and the structured product market for over 25 years. Before setting up CUBE in 2013 David worked at J.P. Morgan, Barclays and RBS. David has worked with and for retail product providers, discretionary managers and institutional investors.