The Pricing of Structured Products in the Swiss Market

Abstract

Payoff patterns that can be achieved with simple option positions are very attractive to many investors. One may distinguish “convex” strategies, with a payoff resembling a long position in a stock portfolio together with a protective put, and “concave” strategies that look like covered calls. Convex strategies offer upside potential if the stock market rises, combined with a fixed minimum payout if the market should Fall. Concave strategies retain the downside risk, give up a portion of the upside, but pay a fixed return in a stable or rising market that is well above the yield on ordinary bonds. Individual investors like these payoffs, but cannot construct them easily on their own using traded instruments. In the 1990s, banks began offering both convex and concave structured products that have proven to be very popular with investors and profitable for the banks. In this article, Burth, Kraus, and Wohlwend examine 275 concave products sold in the Swiss market in the late 1990s, and compare their prices to an estimate of the cost of creating the payoffs using options traded on EUREX. Not surprisingly, they find that prices of the concave products seem to be quite favorable for the banks. They also find considerable pricing dispersion, with distinct differences across different issuing institutions, between products that pay a coupon versus those that do not, and between instruments issued by a single bank versus those with co-lead managers.