Our book “Untold secrets of structured product investing” is built around the analogy of structured products and cocktails. In fact, the book introduces both topics at the same time.
They are similar in terms of how they are designed and how they can be used:
How are structured products designed?
- Both cocktails and structured products are based on a list of basic ingredients and a “recipe” that ensures the ingredients work together in a meaningful way.
- A cocktail is typically designed on a base spirit–e.g. whiskey . Similarly, structured products are based on one (or several) underlying assets – e.g. a stock market index or the gold price.
- There are cocktail ingredients to obtain a certain flavour – e.g. sirup for sweet flavour or lime juice for sour flavour. Likewise, structured products can have convex (“sweet”) ingredients or a concave (“sour”) ingredients.
- The typical “cocktail recipe” for structured products looks like this – a “smartly” weighted package of basic ingredients:
How can structured products be used in a useful way?
- There are cocktails for every type of occasion: celebrations, relaxing times or testing times in life. Likewise, there are structured products that are useful or bullish markets, sideways markets and down markets.
- When drinking cocktails, you need to know your “risk limit”, i.e. how much alcohol you can bear, which may depend on your current situation: is it a Friday night out and you can sleep long on Saturday, or is it a Tuesday night and you know you have an early meeting on Wednesday? Likewise, when investing in structured products you need to know your risk limit, i.e. how much you are willing to lose if markets behave differently from what you expected.
- There are five standard cocktail categories. Likewise, there are four types of structured products, which reflect different market environments and levels of risk taking – see table below. Cocktails / products in each category typically follow similar “recipes”.
Straight up!
- A structured product is a pre-defined package (or shall I say cocktail?) of basic investments such as stocks, bonds and options.
- The design rules (“cocktail recipe”) ensures these basic ingredients work together in a meaningful way to deliver apre-defined payoff at maturity, that depends on the performance of the underlying asset.
- The key advantage of using structured products is that there are products that can gain in any market: upside markets, downside markets or sideway markets.
