Are all Structured Notes Bad?

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talzara
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Re: Are all Structured Notes Bad?

Post by talzara »

Oregano wrote: Fri May 21, 2021 10:40 am If you look at comparable structured notes today, the terms are probably very weak, but the OP got in when volatility was at all-time highs. Obviously it has been a good purchase with hindsight, but if I had been offered some of that in March 2020, I might have bought some myself.
The volatility is already priced in. They are just as good a deal now as they were in March 2020.
Oregano wrote: Fri May 21, 2021 10:40 am P.S. It does trade in the secondary market, but very infrequently. An investor sold some to a dealer at 205.535% of the offering price on 4/23/21. (http://finra-markets.morningstar.com/Bo ... =GS4966899). So the OP could sell now and will have outperformed the broad market by about 40% since purchase (but get less than the mark-to-market value, of course), or hold on and see what happens.
This particular note traded, but most structured notes do not. Take a look at CUSIP 40056YEE0, 40056YRN6, and 40056YFF6. All of these are from March 2020, and none of these have traded even once in the last 12 months. That's not what I'd call liquid.

By the way, these are randomly selected notes. I just went to the SEC filings for Goldman Sachs and clicked on three consecutive notes in March 2020.
Last edited by talzara on Wed Jun 09, 2021 1:23 pm, edited 1 time in total.
talzara
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Re: Are all Structured Notes Bad?

Post by talzara »

Nate79 wrote: Tue Jun 08, 2021 10:06 pm Welcome to Bogleheads and your first post happens to be on structured notes.
Structured notes are not that different from whole life insurance. Maybe we should have a rule for them, too.

I like the watch analogy. Used car salesmen probably wouldn't get as far with it: This car is worth paying double its Blue Book value because you can't assemble a car by yourself!
talzara
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Re: Are all Structured Notes Bad?

Post by talzara »

galeno wrote: Tue Jun 08, 2021 10:36 pm I vote yes. All bad. This is a Boglehead board after all.
On Bogleheads, we consider a 1% annual expense ratio to be high.

The best structured products charge about 1% per year, and the worst structured products charge 2-3% per year. Therefore, all structured products are bad by Bogleheads standards.
talzara
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Re: Are all Structured Notes Bad?

Post by talzara »

David Jay wrote: Tue Jun 08, 2021 9:46 pm
WhenIsADoorNotADoor wrote: Tue Jun 08, 2021 10:30 amConversation 1: Is the average retail investor ever better off buying structured products at times?
I'll take FINRA/SEC on this question: https://www.sec.gov/news/press/2011/2011-118.htm
Here is a quote from the FINRA Senior Vice President for Investor Education:
“The current low interest rate environment might make the potentially higher yields offered by structured notes with principal protection enticing to investors,” said FINRA Senior Vice President for Investor Education John Gannon. “But retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment.”

https://www.sec.gov/news/press/2011/2011-118.htm
All four adjectives apply to the Goldman Sachs note discussed in this thread:
  • Expensive: Goldman Sachs is taking more than 50% of the dividend yield plus the binary put premium.
  • Risky: You still have downside risk, even after giving half the dividends to Goldman and using the other half to buy derivatives.
  • Complex: It is a bundle of seven derivatives.
  • Illiquid: This note traded on only two days over the last year, which is still more frequent than other notes that didn't trade at all!
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Re: Are all Structured Notes Bad?

Post by WhenIsADoorNotADoor »

That SEC doc was from 10 years ago and their organization does not deal in nuance very well. I actually own the same structured note as the original poster, as well as two other 2x pieces that I swapped out of 20/30yr treasury strips to buy as the market was hitting rock bottom. Over the past decade I have scanned thousands of notes and run backtesting on at least a hundred that got through that screening, so what I'm offering is practical experience.

What you find is that 95% of the products out there are either too complicated to trust or under perform simply buying an index - largely because of the dividend give up and also because the market just doesn't have that many periods where you are down significantly enough to take advantage of larger barriers. So why do I buy them? Because sometimes great products do get created (like the above mentioned) and they allow me to swap out a portion of my index ETF holdings and not have to worry as much about portfolio management on those assets - which has value to me.

I feel what the SEC is really talking to investors about when they discuss being skeptical of complexity are things like this current offering - Citi has 5.5 yr principal protected note offering point for point returns and full protection on the following index: CIISDA5N...so what is this? It's the Citi Dynamic Asset Selector 5 Excess Return Index. https://www.citibank.com/icg/docs/CIISD ... tsheet.pdf

This is a very different type of product than what the original poster has. Now is this Citi product bad? No clue. Their performance chart looks nice, but it's not like they were really managing this index back in 2009 so whatever model they created for it potentially just addresses that specific moment and may not have even addressed what happened in 2020 (which they've conveniently left off).

In any case, my point is that an SPX or SPX/DJI note is SUPER vanilla in comparison to what's out there and shouldn't be conflated with what the SEC statements are, in my eyes, really about. And of course you should take into account the dividend give up, but 2x over multiple years historically offers outperformance, and 40% is a huge barrier that in a doomsday scenario puts a ton of cash back in your pocket if the market's down.

Yes, I know that this is a Bogleheads forum, so the expertise for some is high, and that's great. But obviously the original poster would have created the options strategy if they had the time/interest/expertise at that time. My point is that a more constructive way to discuss this is probably to acknowledge that for this person at that time, this was a great trade, and also that there is room to create something cheaper on their own if they want to learn how to apply it in the future. I usually don't do anything other than read these forums because I'm not an expert, but I do have insight on this and see a ton of misinformation constantly about structured notes, so I thought I'd chime in.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

WhenIsADoorNotADoor wrote: Thu Jun 10, 2021 9:08 am That SEC doc was from 10 years ago and their organization does not deal in nuance very well. I actually own the same structured note as the original poster, as well as two other 2x pieces that I swapped out of 20/30yr treasury strips to buy as the market was hitting rock bottom. Over the past decade I have scanned thousands of notes and run backtesting on at least a hundred that got through that screening, so what I'm offering is practical experience.

What you find is that 95% of the products out there are either too complicated to trust or under perform simply buying an index - largely because of the dividend give up and also because the market just doesn't have that many periods where you are down significantly enough to take advantage of larger barriers. So why do I buy them? Because sometimes great products do get created (like the above mentioned) and they allow me to swap out a portion of my index ETF holdings and not have to worry as much about portfolio management on those assets - which has value to me.

I feel what the SEC is really talking to investors about when they discuss being skeptical of complexity are things like this current offering - Citi has 5.5 yr principal protected note offering point for point returns and full protection on the following index: CIISDA5N...so what is this? It's the Citi Dynamic Asset Selector 5 Excess Return Index. https://www.citibank.com/icg/docs/CIISD ... tsheet.pdf

This is a very different type of product than what the original poster has. Now is this Citi product bad? No clue. Their performance chart looks nice, but it's not like they were really managing this index back in 2009 so whatever model they created for it potentially just addresses that specific moment and may not have even addressed what happened in 2020 (which they've conveniently left off).

In any case, my point is that an SPX or SPX/DJI note is SUPER vanilla in comparison to what's out there and shouldn't be conflated with what the SEC statements are, in my eyes, really about. And of course you should take into account the dividend give up, but 2x over multiple years historically offers outperformance, and 40% is a huge barrier that in a doomsday scenario puts a ton of cash back in your pocket if the market's down.

Yes, I know that this is a Bogleheads forum, so the expertise for some is high, and that's great. But obviously the original poster would have created the options strategy if they had the time/interest/expertise at that time. My point is that a more constructive way to discuss this is probably to acknowledge that for this person at that time, this was a great trade, and also that there is room to create something cheaper on their own if they want to learn how to apply it in the future. I usually don't do anything other than read these forums because I'm not an expert, but I do have insight on this and see a ton of misinformation constantly about structured notes, so I thought I'd chime in.
Unfortunately, it seems that fully evaluating these products requires a comparable level of expertise as reconstructing them using options. (It's easier to tell that some are true lemons, but to be relatively sure that the product is fair and actually does what you want it to takes a lot of expertise). I'm sure there are people who have that expertise and then would rather pay the implicit fees instead of doing the work themselves. You seem to be one of them. But those people are likely to be very, very rare.
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talzara
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Re: Are all Structured Notes Bad?

Post by talzara »

WhenIsADoorNotADoor wrote: Thu Jun 10, 2021 9:08 am That SEC doc was from 10 years ago and their organization does not deal in nuance very well. ... I feel what the SEC is really talking to investors about when they discuss being skeptical of complexity are things like this current offering - Citi has 5.5 yr principal protected note offering point for point returns and full protection on the following index: CIISDA5N...so what is this? It's the Citi Dynamic Asset Selector 5 Excess Return Index. https://www.citibank.com/icg/docs/CIISD ... tsheet.pdf
The SEC page is from 2011. The "super vanilla" notes are precisely the ones that the SEC is calling "expensive, risky, complex and illiquid."

Your Citibank example shows that the SEC was right. Instead of simplifying the products, the investment banks have made them even more complex over the last 10 years.

That doesn't make the Goldman Sachs note simple. It just makes the Citibank note "expensive, risky, super-complex and illiquid."
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Re: Are all Structured Notes Bad?

Post by talzara »

HootingSloth wrote: Thu Jun 10, 2021 9:16 am Unfortunately, it seems that fully evaluating these products requires a comparable level of expertise as reconstructing them using options. (It's easier to tell that some are true lemons, but to be relatively sure that the product is fair and actually does what you want it to takes a lot of expertise). I'm sure there are people who have that expertise and then would rather pay the implicit fees instead of doing the work themselves. You seem to be one of them. But those people are likely to be very, very rare.
Instead of a "comparable level of expertise," we actually see an example of exactly the same psychological trap that the OP fell into:
WhenIsADoorNotADoor wrote: Thu Jun 10, 2021 9:08 am And of course you should take into account the dividend give up, but 2x over multiple years historically offers outperformance, and 40% is a huge barrier that in a doomsday scenario puts a ton of cash back in your pocket if the market's down.
The OP wrote in the first post that you give up the dividends, brushed it aside, and immediately got distracted by "enhanced returns." People are so dazzled by the 2x leveraged returns that they don't notice Goldman picking their pocket.

However, Goldman is making its profit on the dividends! You pay them 100% of the dividends, but they only give you 50% of the value back as derivatives. Anyone who brushes aside the dividends doesn't truly understand this note.

The dividends are what make this note possible. Without the dividends, Goldman would have to sell the note at above par. Then all the psychological biases would work in the other direction. Who would want to pay $1,175 for a $1,000 note?
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Thu Jun 10, 2021 12:18 pm
HootingSloth wrote: Thu Jun 10, 2021 9:16 am Unfortunately, it seems that fully evaluating these products requires a comparable level of expertise as reconstructing them using options. (It's easier to tell that some are true lemons, but to be relatively sure that the product is fair and actually does what you want it to takes a lot of expertise). I'm sure there are people who have that expertise and then would rather pay the implicit fees instead of doing the work themselves. You seem to be one of them. But those people are likely to be very, very rare.
Instead of a "comparable level of expertise," we actually see an example of exactly the same psychological trap that the OP fell into:
WhenIsADoorNotADoor wrote: Thu Jun 10, 2021 9:08 am And of course you should take into account the dividend give up, but 2x over multiple years historically offers outperformance, and 40% is a huge barrier that in a doomsday scenario puts a ton of cash back in your pocket if the market's down.
The OP wrote in the first post that you give up the dividends, brushed it aside, and immediately got distracted by "enhanced returns." People are so dazzled by the 2x leveraged returns that they don't notice Goldman picking their pocket.

However, Goldman is making its profit on the dividends! You pay them 100% of the dividends, but they only give you 50% of the value back as derivatives. Anyone who brushes aside the dividends doesn't truly understand this note.

The dividends are what make this note possible. Without the dividends, Goldman would have to sell the note at above par. Then all the psychological biases would work in the other direction. Who would want to pay $1,175 for a $1,000 note?
Your take seems uncharitable to me. It seems likely that WhenIsADoorNotADoor knows what he is paying. It does not seem to me obviously absurd to be willing to pay an ~1% annual fee to avoid the need to do all of the mechanics yourself and to avoid execution risk if the return profile of this instrument is truly what you want and a DIY approach is unappealing. Of course, it could be that he does not understand what he is paying. I would not have without the discussion here (or maybe I still don't since I don't have the necessary expertise myself). But if he does understand that, then deciding whether it is worth it seems like a personal decision.

My actual point was that anyone who looks at that note and cannot, at a minimum, say something like "Here's the seven options I would need to buy to recreate this and here is how much it would cost to do that" probably should NOT be buying this. I would guess that includes virtually everyone who might ask an online message board whether it makes sense to buy such a thing.
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talzara
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Re: Are all Structured Notes Bad?

Post by talzara »

HootingSloth wrote: Thu Jun 10, 2021 3:07 pm Your take seems uncharitable to me. It seems likely that WhenIsADoorNotADoor knows what he is paying. It does not seem to me obviously absurd to be willing to pay an ~1% annual fee to avoid the need to do all of the mechanics yourself and to avoid execution risk if the return profile of this instrument is truly what you want and a DIY approach is unappealing. Of course, it could be that he does not understand what he is paying. I would not have without the discussion here (or maybe I still don't since I don't have the necessary expertise myself).
The structured note consists of a bond that pays 0% interest, stapled to a bundle of 7 derivatives.

You don't need to pay Goldman Sachs 1% a year to hold a bond that pays 0% interest. Just put the money in a CD at the bank. You'll get FDIC insurance, and you'll even get paid interest.

People buy this note to get the derivatives. After taking 50% of the dividends and 100% of the premium for the binary put, Goldman is charging almost 10% a year on the initial value of the derivatives.

10% a year is a very high fee to manage a bundle of 7 derivatives that does not change. Goldman is not doing any active management of the derivatives portfolio. It's the same 7 derivatives until the note matures.
HootingSloth wrote: Thu Jun 10, 2021 3:07 pm But if he does understand that, then deciding whether it is worth it seems like a personal decision.
It's also a personal decision to buy whole life insurance, but we criticize whole life insurance a lot on Bogleheads.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Thu Jun 10, 2021 8:33 pm It's also a personal decision to buy whole life insurance, but we criticize whole life insurance a lot on Bogleheads.
Indeed. You will also see me criticizing structured notes in every single post I have made in this thread.

Whole life insurance seems to me like a good analogy: potentially worthwhile in a very narrow range of circumstances but pushed on lots people where it is not close to suitable for them by using obscurity and complexity.
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Re: Are all Structured Notes Bad?

Post by Stinky »

HootingSloth wrote: Thu Jun 10, 2021 9:13 pm Whole life insurance seems to me like a good analogy: potentially worthwhile in a very narrow range of circumstances but pushed on lots people where it is not close to suitable for them by using obscurity and complexity.
Seems to me like that’s a really good analogy.

There’s a certain “mystique” that surrounds both structured notes and whole life.
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Re: Are all Structured Notes Bad?

Post by Elric »

I used to own a number of structured notes of various types, including one similar, but not quite as attractive, as this one. I don't think decent ones, like this one, are as bad as some make them out to be. I understand that it may be possible for the individual investor to put together something similar over such an extended period for cheaper than buying a note, yielding a higher return. There's a lot of things I'm willing to pay people to do things I don't want to or can't do myself it still yields value to me.

I've seen horrible structured products and ones I'd call decent like this one. I made pretty good returns on several, but there was downside risk on those that didn't occur.

But the important bottom line is that I decided some time ago that they don't really serve a need I need to fill in my investment portfolio, and I suspect this is the same for most others. So while some structured notes aren't the total ripoff that some people would make them out to be, even for the better ones, why pay a premium for something you don't really need?
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Re: Are all Structured Notes Bad?

Post by Oregano »

talzara wrote: Wed Jun 09, 2021 1:12 pm
Oregano wrote: Fri May 21, 2021 10:40 am If you look at comparable structured notes today, the terms are probably very weak, but the OP got in when volatility was at all-time highs. Obviously it has been a good purchase with hindsight, but if I had been offered some of that in March 2020, I might have bought some myself.
The volatility is already priced in. They are just as good a deal now as they were in March 2020.
Good god, no, that's wrong. If stocks have dropped 30% and the VIX is at 80, it not the same as with current stock prices and VIX at 16. You are correct that it's priced in, but that does not make it the same.
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Re: Are all Structured Notes Bad?

Post by Oregano »

talzara wrote: Wed Jun 09, 2021 1:12 pm
Oregano wrote: Fri May 21, 2021 10:40 am P.S. It does trade in the secondary market, but very infrequently. An investor sold some to a dealer at 205.535% of the offering price on 4/23/21. (http://finra-markets.morningstar.com/Bo ... =GS4966899). So the OP could sell now and will have outperformed the broad market by about 40% since purchase (but get less than the mark-to-market value, of course), or hold on and see what happens.
This particular note traded, but most structured notes do not. Take a look at CUSIP 40056YEE0, 40056YRN6, and 40056YFF6. All of these are from March 2020, and none of these have traded even once in the last 12 months. That's not what I'd call liquid.

By the way, these are randomly selected notes. I just went to the SEC filings for Goldman Sachs and clicked on three consecutive notes in March 2020.
If you request bids through your broker for those CUSIPs, you will most likely get some sort of bid. It may or may not be a good bid. I didn't actually say they were highly liquid, but others had implied they could not be traded at all, which is false.
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Re: Are all Structured Notes Bad?

Post by talzara »

Oregano wrote: Fri Jun 11, 2021 12:49 pm
talzara wrote: Wed Jun 09, 2021 1:12 pm
Oregano wrote: Fri May 21, 2021 10:40 am If you look at comparable structured notes today, the terms are probably very weak, but the OP got in when volatility was at all-time highs. Obviously it has been a good purchase with hindsight, but if I had been offered some of that in March 2020, I might have bought some myself.
The volatility is already priced in. They are just as good a deal now as they were in March 2020.
Good god, no, that's wrong. If stocks have dropped 30% and the VIX is at 80, it not the same as with current stock prices and VIX at 16. You are correct that it's priced in, but that does not make it the same.
How did you know that stocks wouldn't drop even more than 30%?

If you could predict the future and knew that stocks wouldn't keep dropping, then why buy this note? You were buying downside protection that you didn't need, and you were paying a lot of money for it because volatility was high. Just leverage up to 200% and buy an index fund.

If you're saying that derivatives prices don't accurately represent the risk, then it actually proves the opposite of your previous post. The Goldman Sachs note from March 2020 would be worse than "comparable structured notes today," not better. You actually need downside protection when stocks are at all-time highs. The derivatives would also be cheap because volatility is low.
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Re: Are all Structured Notes Bad?

Post by Oregano »

talzara wrote: Fri Jun 11, 2021 1:40 pm
Oregano wrote: Fri Jun 11, 2021 12:49 pm
talzara wrote: Wed Jun 09, 2021 1:12 pm
Oregano wrote: Fri May 21, 2021 10:40 am If you look at comparable structured notes today, the terms are probably very weak, but the OP got in when volatility was at all-time highs. Obviously it has been a good purchase with hindsight, but if I had been offered some of that in March 2020, I might have bought some myself.
The volatility is already priced in. They are just as good a deal now as they were in March 2020.
Good god, no, that's wrong. If stocks have dropped 30% and the VIX is at 80, it not the same as with current stock prices and VIX at 16. You are correct that it's priced in, but that does not make it the same.
How did you know that stocks wouldn't drop even more than 30%?

If you could predict the future and knew that stocks wouldn't keep dropping, then why buy this note? You were buying downside protection that you didn't need, and you were paying a lot of money for it because volatility was high. Just leverage up to 200% and buy an index fund.

If you're saying that derivatives prices don't accurately represent the risk, then it actually proves the opposite of your previous post. The Goldman Sachs note from March 2020 would be worse than "comparable structured notes today," not better. You actually need downside protection when stocks are at all-time highs. The derivatives would also be cheap because volatility is low.
No, when VIX was 80, it allowed for much more upside relative to the same downside protection as when VIX is 16. I think you already acknowledged that in another comment.

Part of the mark-to-market price increase is based on the underlying indexes going up, and part is based on VIX collapsing from 80 to 16. I do believe the latter part was a pretty easy bet to make.
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Re: Are all Structured Notes Bad?

Post by talzara »

Oregano wrote: Fri Jun 11, 2021 12:52 pm If you request bids through your broker for those CUSIPs, you will most likely get some sort of bid. It may or may not be a good bid. I didn't actually say they were highly liquid, but others had implied they could not be traded at all, which is false.
I never said that. This is what I actually said:
talzara wrote: Sun Jun 21, 2020 2:28 pm
UsualLine wrote: Sat Jun 20, 2020 10:16 am Is there a secondary market for these? At some price they will be a value.
I don't see how there could be enough liquidity to trade. LEAPS that are far out of the money can go weeks between trades, and those are on heavily-traded ETFs with expiration dates within the next three years. These structured notes are even longer-dated, and they have more complex payoff profiles on multiple indexes. There might only be one trade a year.
I said there might be "one trade a year," not zero trades. I was actually too optimistic. The data shows that the average structured note trades less often than once a year. You're trying to make structured notes look better, but it turns out they're even worse than I said they were.

Also, I was replying to someone who wanted to buy structured notes on the secondary market. They weren't trying to sell structured notes to get their money out. That is why I said that one trade a year would not be "enough liquidity to trade." How can you build an investing strategy around something that trades less often than once a year? A dealer could do it, but the individual investor is at a disadvantage.
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Re: Are all Structured Notes Bad?

Post by Oregano »

talzara wrote: Fri Jun 11, 2021 1:56 pm
Oregano wrote: Fri Jun 11, 2021 12:52 pm If you request bids through your broker for those CUSIPs, you will most likely get some sort of bid. It may or may not be a good bid. I didn't actually say they were highly liquid, but others had implied they could not be traded at all, which is false.
I never said that. This is what I actually said:
talzara wrote: Sun Jun 21, 2020 2:28 pm
UsualLine wrote: Sat Jun 20, 2020 10:16 am Is there a secondary market for these? At some price they will be a value.
I don't see how there could be enough liquidity to trade. LEAPS that are far out of the money can go weeks between trades, and those are on heavily-traded ETFs with expiration dates within the next three years. These structured notes are even longer-dated, and they have more complex payoff profiles on multiple indexes. There might only be one trade a year.
I said there might be "one trade a year," not zero trades. I was actually too optimistic. The data shows that the average structured note trades less often than once a year. You're trying to make structured notes look better, but it turns out they're even worse than I said they were.

Also, I was replying to someone who wanted to buy structured notes on the secondary market. They weren't trying to sell structured notes to get their money out. That is why I said that one trade a year would not be "enough liquidity to trade." How can you build an investing strategy around something that trades less often than once a year? A dealer could do it, but the individual investor is at a disadvantage.
I'm not recommending anyone actually buy or sell structured notes in the secondary market - you are not going to get good pricing through most brokers. But it is misleading to say "they only trade once a year". The point is, if you own some and want to sell yours, you most likely can get a bid most days of the year. So it doesn't matter if it hasn't traded in a year; you get a bid and decide if you want to sell. That's actually common for lots of bonds, including thousands of municipals.

That process absolutely does NOT work for trying to buy; god help you if created a list of CUSIPs and wanted to go out and buy them as that will never work. You can only look at what is on offer and decide if the price is right.
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Re: Are all Structured Notes Bad?

Post by talzara »

Oregano wrote: Fri Jun 11, 2021 1:54 pm No, when VIX was 80, it allowed for much more upside relative to the same downside protection as when VIX is 16. I think you already acknowledged that in another comment.

Part of the mark-to-market price increase is based on the underlying indexes going up, and part is based on VIX collapsing from 80 to 16. I do believe the latter part was a pretty easy bet to make.
That's already priced in as well.

The financial engineers at Goldman Sachs aren't that naive. They know the VIX will not stay at 80 for 6.8 years. They're not just plugging numbers into the Black-Scholes equation, which is a closed-form solution that makes simplifying assumptions. They're running stochastic simulations on computers, and they've already priced in the expected decline in volatility.

If you believe that you're better at pricing derivatives than Goldman Sachs, I can only say good luck.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Fri Jun 11, 2021 2:24 pm
Oregano wrote: Fri Jun 11, 2021 1:54 pm No, when VIX was 80, it allowed for much more upside relative to the same downside protection as when VIX is 16. I think you already acknowledged that in another comment.

Part of the mark-to-market price increase is based on the underlying indexes going up, and part is based on VIX collapsing from 80 to 16. I do believe the latter part was a pretty easy bet to make.
That's already priced in as well.

The financial engineers at Goldman Sachs aren't that naive. They know the VIX will not stay at 80 for 6.8 years. They're not just plugging numbers into the Black-Scholes equation, which is a closed-form solution that makes simplifying assumptions. They're running stochastic simulations on computers, and they've already priced in the expected decline in volatility.

If you believe that you're better at pricing derivatives than Goldman Sachs, I can only say good luck.
I don't think you, necessarily and always, need to be better at pricing derivatives than Goldman. From my second-hand understanding, much of what goes into structuring these products is the financial institution or, more often, one or more of its clients, already having an exposure that they want to eliminate by being on the other side of these trades. This is what puts them in a position to offer a product on terms that are better than what other competing financial institutions can offer. So, it may not be Goldman folks running stochastic simulations that are, in practice, sitting on the other side but some collection of large corporate clients that wanted opposing hedges that added up to offset this position. It's a more complicated version of a typical broker role, where all Goldman wants is to take a spread, and it is matching a bunch of different folks on various sides so that its exposure nets out to nothing. In addition, I understand there is some amount of "too big too fail" factor that is taken into account here where the financial institution believes that risk is effectively being shifted to the taxpaying public.

None of this is to say that any given product is a good buy--or that it is easy to tell what is or isn't a good buy--just that, from what I have heard from someone who makes the sausage, it is possible (but rare) for these to be worthwhile for someone who wants a particular return profile, without requiring you to have outsmarted some (very smart) bankers.
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Re: Are all Structured Notes Bad?

Post by talzara »

Oregano wrote: Fri Jun 11, 2021 2:04 pm I'm not recommending anyone actually buy or sell structured notes in the secondary market - you are not going to get good pricing through most brokers. But it is misleading to say "they only trade once a year". The point is, if you own some and want to sell yours, you most likely can get a bid most days of the year. So it doesn't matter if it hasn't traded in a year; you get a bid and decide if you want to sell. That's actually common for lots of bonds, including thousands of municipals.
As I already pointed out, I was replying to someone who was interested in buying structured notes. You just repeated what you said about selling structured notes.

We criticize lots of investments on Bogleheads. There's no reason that structured notes should be exempt from the same criticism. In Bogleheads threads about buying individual municipal bonds, people often point out that they're illiquid and trade infrequently.
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Re: Are all Structured Notes Bad?

Post by HueyLD »

The only thing I can say about structured notes is as follows:

“Fool me once, shame on you. Fool me twice, shame on me.”

That’s why the commission is very generous to encourage aggressive sale tactics.
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Re: Are all Structured Notes Bad?

Post by vineviz »

WhenIsADoorNotADoor wrote: Tue Jun 08, 2021 10:30 am I see cart blanche arguments against structured products being made continuously by individuals who have the background, expertise and interest in managing multiple options contracts over long periods of time. Unfortunately, this represents a sliver of retail investors, most of whom don't have the interest in investing in options at all.
People who understand how to replicate the payoffs of structured notes don’t advocate against them ONLY because the notes can be replicated.

I’ve never met an individual investor who actually NEEDED the precise payoff of a structured note (or the growing array of ETFs offering structured payoffs) and whose need couldn’t be met using a simpler and cheaper combination of stocks and bonds.
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Re: Are all Structured Notes Bad?

Post by talzara »

HootingSloth wrote: Fri Jun 11, 2021 2:36 pm I don't think you, necessarily and always, need to be better at pricing derivatives than Goldman. From my second-hand understanding, much of what goes into structuring these products is the financial institution or, more often, one or more of its clients, already having an exposure that they want to eliminate by being on the other side of these trades. This is what puts them in a position to offer a product on terms that are better than what other competing financial institutions can offer. So, it may not be Goldman folks running stochastic simulations that are, in practice, sitting on the other side but some collection of large corporate clients that wanted opposing hedges that added up to offset this position. It's a more complicated version of a typical broker role, where all Goldman wants is to take a spread, and it is matching a bunch of different folks on various sides so that its exposure nets out to nothing. In addition, I understand there is some amount of "too big too fail" factor that is taken into account here where the financial institution believes that risk is effectively being shifted to the taxpaying public.
If the structured note is netted out, then it can only be underpriced if the other side is overpriced. Is it more likely that Goldman would be ripping off the individual investor buying structured notes, or the "large corporate clients" on the other side?

Also, who would want to take the other side of this structured note? Who would want to take the other side of the 40% downside protection? Who would want to hedge out 200% of the worst-of-two upside of the DJIA and the S&P 500? Maybe Goldman has two clients: one for the DJIA and the other for the S&P 500. In that case, Goldman is on the hook for the worst-of-two, so we're back to Goldman acting as a market maker and doing dynamic hedging of the option.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Fri Jun 11, 2021 3:13 pm
HootingSloth wrote: Fri Jun 11, 2021 2:36 pm I don't think you, necessarily and always, need to be better at pricing derivatives than Goldman. From my second-hand understanding, much of what goes into structuring these products is the financial institution or, more often, one or more of its clients, already having an exposure that they want to eliminate by being on the other side of these trades. This is what puts them in a position to offer a product on terms that are better than what other competing financial institutions can offer. So, it may not be Goldman folks running stochastic simulations that are, in practice, sitting on the other side but some collection of large corporate clients that wanted opposing hedges that added up to offset this position. It's a more complicated version of a typical broker role, where all Goldman wants is to take a spread, and it is matching a bunch of different folks on various sides so that its exposure nets out to nothing. In addition, I understand there is some amount of "too big too fail" factor that is taken into account here where the financial institution believes that risk is effectively being shifted to the taxpaying public.
If the structured note is netted out, then it can only be underpriced if the other side is overpriced. Is it more likely that Goldman would be ripping off the individual investor buying structured notes, or the "large corporate clients" on the other side?

Also, who would want to take the other side of this structured note? Who would want to take the other side of the 40% downside protection? Who would want to hedge out 200% of the worst-of-two upside of the DJIA and the S&P 500? Maybe Goldman has two clients: one for the DJIA and the other for the S&P 500. In that case, Goldman is on the hook for the worst-of-two, so we're back to Goldman acting as a market maker and doing dynamic hedging of the option.
As far as I understand, the point is not that the large corporate clients are getting a good or bad deal. The point is that they have their own, unrelated exposures that push them into wanting to be on the other side on relatively neutral pricing terms, with the bank, of course, taking home a very nice spread for setting all of this up.

Again, I very much do not have enough expertise to make these kinds of judgments about individual instruments, and I have no idea whether this particular note is OK or awful. I am reporting what a trusted friend has told me who worked in this area. In case you are wondering, he was not trying to "sell" me on anything as he told me not to bother. Moreover, as I explained earlier, he eventually left at least in part because he thought that most people buying the products he was designing were not well served by buying them.

In case this has not been clear: I would not recommend anyone to invest in a structured note unless they have a very strong background in financial engineering. In other words, if you have to ask anyone else whether you should buy, the answer is no. If someone does have the required background, and they can understand what they are getting and what they are paying, I do not think we should sit here and insist they are being fools. As a bottom line, I think the answer to the question "Are All Structured Notes Bad?" is "No, but unless you could get a job creating them, you should probably assume they are bad for you."
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Re: Are all Structured Notes Bad?

Post by alex_686 »

Inverting the response so it flows better.
talzara wrote: Fri Jun 11, 2021 3:13 pm Also, who would want to take the other side of this structured note? Who would want to take the other side of the 40% downside protection? Who would want to hedge out 200% of the worst-of-two upside of the DJIA and the S&P 500? Maybe Goldman has two clients: one for the DJIA and the other for the S&P 500. In that case, Goldman is on the hook for the worst-of-two, so we're back to Goldman acting as a market maker and doing dynamic hedging of the option.
The market. I am highly confident that Goldman is not on the other side of this note. I am very doubtful that there is a specific party on the other side, even though it sometimes happens. You should be able to replicate the notes using publicly traded options.
talzara wrote: Fri Jun 11, 2021 3:13 pm If the structured note is netted out, then it can only be underpriced if the other side is overpriced. Is it more likely that Goldman would be ripping off the individual investor buying structured notes, or the "large corporate clients" on the other side?
This is like arguing that index funds are bad because Vanguard takes a cut to manage the fund. The argument does not make any sense. I am sure we could deconstruct the product and estimate Goldman's profit. It probably is on the high side, but certainly not a "rip off".
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Re: Are all Structured Notes Bad?

Post by talzara »

HootingSloth wrote: Fri Jun 11, 2021 3:24 pm As far as I understand, the point is not that the large corporate clients are getting a good or bad deal. The point is that they have their own, unrelated exposures that push them into wanting to be on the other side on relatively neutral pricing terms, with the bank, of course, taking home a very nice spread for setting all of this up. ... If someone does have the required background, and they can understand what they are getting and what they are paying, I do not think we should sit here and insist they are being fools.
The person with "the required background" is saying that this note makes money when the VIX falls from 80 to 16. If the investor is making money by selling volatility, then the derivatives have to be priced too high. This means that the counterparty's derivatives have to be priced too low.

It is not enough to say that there is a counterparty. What position is the counterparty actually taking?

Financial engineering is just math. The cash flows have to work out.
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Re: Are all Structured Notes Bad?

Post by talzara »

alex_686 wrote: Fri Jun 11, 2021 3:34 pm The market. I am highly confident that Goldman is not on the other side of this note. I am very doubtful that there is a specific party on the other side, even though it sometimes happens. You should be able to replicate the notes using publicly traded options.
There are no publicly-traded 7-year European options. I explained this last year.

Since there are no publicly-traded options, the investment bank can't net it out to "the market" either. If it is netted out, then there has to be a customer. Since there are so many legs to this trade, it may be a combination of customers. One customer may take the S&P 500 and another customer the DJIA, but then Goldman has to act as an options market maker for the worst-of-two risk.
alex_686 wrote: Fri Jun 11, 2021 3:34 pm This is like arguing that index funds are bad because Vanguard takes a cut to manage the fund. The argument does not make any sense. I am sure we could deconstruct the product and estimate Goldman's profit. It probably is on the high side, but certainly not a "rip off".
No, it is like arguing that hedge funds are bad when they charge two-and-twenty. Vanguard charges a lot less.

I already deconstructed the structured note into its underlying derivatives last year. viewtopic.php?p=5324880#p5324880

Goldman is charging double the fair value of the options bundle. If that is not a rip-off, I'd like to know what you actually consider to be a rip-off. Triple? Quadruple? 10 times fair value?
Last edited by talzara on Fri Jun 11, 2021 3:58 pm, edited 1 time in total.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Fri Jun 11, 2021 3:42 pm
HootingSloth wrote: Fri Jun 11, 2021 3:24 pm As far as I understand, the point is not that the large corporate clients are getting a good or bad deal. The point is that they have their own, unrelated exposures that push them into wanting to be on the other side on relatively neutral pricing terms, with the bank, of course, taking home a very nice spread for setting all of this up. ... If someone does have the required background, and they can understand what they are getting and what they are paying, I do not think we should sit here and insist they are being fools.
The person with "the required background" is saying that this note makes money when the VIX falls from 80 to 16. If the investor is making money by selling volatility, then the derivatives have to be priced too high. This means that the counterparty's derivatives have to be priced too low.

It is not enough to say that there is a counterparty. What position is the counterparty actually taking?

Financial engineering is just math. The cash flows have to work out.
I do not know who is right in this particular instance about the impact of VIX or whether you or the person you are arguing with has the required background. I do know that I trust my friend who designed these kinds of instruments for a living more than I trust an internet stranger about the general facts about how these are put together.
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Re: Are all Structured Notes Bad?

Post by talzara »

HootingSloth wrote: Fri Jun 11, 2021 3:56 pm I do not know who is right in this particular instance about the impact of VIX or whether you or the person you are arguing with has the required background. I do know that I trust my friend who designed these kinds of instruments for a living more than I trust an internet stranger about the general facts about how these are put together.
Derivatives are zero-sum. The money has to come from somewhere, and it's probably not coming from Goldman mispricing the derivatives on the other side of the trade.

"I trust my friend" doesn't explain where the money is coming from.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Fri Jun 11, 2021 4:03 pm
HootingSloth wrote: Fri Jun 11, 2021 3:56 pm I do not know who is right in this particular instance about the impact of VIX or whether you or the person you are arguing with has the required background. I do know that I trust my friend who designed these kinds of instruments for a living more than I trust an internet stranger about the general facts about how these are put together.
Derivatives are zero-sum. The money has to come from somewhere, and it's probably not coming from Goldman mispricing the derivatives on the other side of the trade.

"I trust my friend" doesn't explain where the money is coming from.
Yes, it is (for the most part) zero-sum. The counterparties are paying a portion of the implicit fees to the bank, and the person buying this note is paying a portion. (Although, if the worst-case risks are realized, the government and taxpayers might, instead, be left holding the bag, and the bank, the counterparty, and the note holder might all be effectively getting some benefit of this risk shifting through the pricing terms). The bank gets paid no matter what happens because it is providing a service of delivering different return profiles to different clients that can be difficult for the clients to construct on their own. It's certainly possible that the bank is being overpaid, or that the counterparty or the note holder is just plain wrong about wanting that return profile or how much it is worth paying to get it. In fact, at least for the note holder, that seems to be by far the most common result. But it is not inevitably and always the case.
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Re: Are all Structured Notes Bad?

Post by talzara »

HootingSloth wrote: Fri Jun 11, 2021 4:12 pm Yes, it is (for the most part) zero-sum. The counterparties are paying a portion of the implicit fees to the bank, and the person buying this note is paying a portion. (Although, if the worst-case risks are realized, the government and taxpayers might, instead, be left holding the bag, and the bank, the counterparty, and the note holder might all be effectively getting some benefit of this risk shifting through the pricing terms). The bank gets paid no matter what happens because it is providing a service of delivering different return profiles to different clients that can be difficult for the clients to construct on their own. It's certainly possible that the bank is being overpaid, or that the counterparty or the note holder is just plain wrong about wanting that return profile or how much it is worth paying to get it. In fact, at least for the note holder, that seems to be by far the most common result. But it is not inevitably and always the case.
It's not impossible for a structured note to be favorable to the investor. Even Goldman Sachs employees must make a mistake once in a while. However, I've never seen one structured note that was a good investment.

SLCG, which provides PhD expert witnesses for securities litigation, used to do fair value analysis of structured notes. Their website still has a database of 20,912 structured notes that they analyzed in 2007-2014, but it keeps timing out past the first few pages: https://www.slcg.com/securities-structu ... ducts2.php

Several years ago, when their website still worked, I clicked on a random sampling of fair value reports for index-linked structured products. I didn't read the whole report, but I just compared the cost to the dividend yield on the underlying. Every structured note had very high fees. Some were just bad, some were terrible, and some were horrible. There were structured notes that charged twice as much as this Goldman Sachs note. There were also structured notes that charged less.

SLCG no longer analyzes structured notes, but every structured note that I've ever looked at was also bad.

If structured notes can actually be good for the investor, then it shouldn't be this hard to find one. Just one.
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Re: Are all Structured Notes Bad?

Post by alex_686 »

talzara wrote: Fri Jun 11, 2021 3:55 pm There are no publicly-traded 7-year European options. I explained this last year.
You are wrong. The CME offers these swaptions with tennors up to 30 years since 2016. I will admit that this is a obscure part of the market but there you go.

But even if not, who cares? You can create a dynamically hedge strategy for tennors longer than what is available. Yeah, it gets trickery - but that is model risk, not market risk.
alex_686 wrote: Fri Jun 11, 2021 3:34 pm No, it is like arguing that hedge funds are bad when they charge two-and-twenty. Vanguard charges a lot less.
I am confused. Hedge funds don't charge 2 and 20. And even if they did, so what? They are charging a different price for a different product. And a structured fund is neither a mutual fund nor a hedge fund. Or is your argument that the only valid ice cream in vanilla and that all other flavors are rip offs?
alex_686 wrote: Fri Jun 11, 2021 3:34 pm I already deconstructed the structured note into its underlying derivatives last year. viewtopic.php?p=5324880#p5324880
I have not had time to pick this apart, but I have already found a error. I will get back.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Fri Jun 11, 2021 5:42 pm
HootingSloth wrote: Fri Jun 11, 2021 4:12 pm Yes, it is (for the most part) zero-sum. The counterparties are paying a portion of the implicit fees to the bank, and the person buying this note is paying a portion. (Although, if the worst-case risks are realized, the government and taxpayers might, instead, be left holding the bag, and the bank, the counterparty, and the note holder might all be effectively getting some benefit of this risk shifting through the pricing terms). The bank gets paid no matter what happens because it is providing a service of delivering different return profiles to different clients that can be difficult for the clients to construct on their own. It's certainly possible that the bank is being overpaid, or that the counterparty or the note holder is just plain wrong about wanting that return profile or how much it is worth paying to get it. In fact, at least for the note holder, that seems to be by far the most common result. But it is not inevitably and always the case.
It's not impossible for a structured note to be favorable to the investor. However, I've never seen one.

Even Goldman Sachs employees must make a mistake once in a while. Lottery drawings occasionally have positive expected value, too.

SLCG, which provides PhD expert witnesses for securities litigation, used to do fair value analysis of structured notes. Their website still has a database of 20,912 structured notes that they analyzed in 2007-2014, but it keeps timing out past the first few pages: https://www.slcg.com/securities-structu ... ducts2.php

Several years ago, when their website still worked, I clicked on a random sampling of fair value reports for index-linked structured products. I didn't read the whole report, but I just compared the cost to the dividend yield on the underlying. Every structured note had very high fees. The Goldman Sachs note in this thread is not the worst structured note that was sold to investors. There are structured notes that charge more than 100% of the dividend yield!

I haven't looked at all 20,912 reports, but every one that I looked at was bad. Some were just bad, some were terrible, and some were horrible. If structured notes were actually good for the investor, then it shouldn't be this hard to find one. Just one.
There seems to be some degree of talking past each other here, so I will try to be clear where we agree and where we appear to disagree. The fees are very, very high. If you are giving up 1% of your returns, or more, you better be damn sure that you are getting something really worthwhile for it. And it is often very hard to tell both what you are getting and what you are actually paying for it. As vineviz pointed out upthread, individual retail investors almost never have a real need for getting to the particular return profile that these notes provide, so it does not make sense for them to pay 1% to get it. I completely agree with that. For that reason, structured notes are almost never suitable for retail investors. If you have to ask whether you should buy one, the answer is almost surely no.

However, the bank employees do not need to make a mistake for this to be worthwhile to somebody. The bank is not sitting on the other side of these. They are effectively just collecting a spread. They are not designing them to take advantage of anyone's psychological weaknesses. They are designing them to deliver the counterparties what the counterparties are asking for, while making sure that the bank bears as little risk as possible (except, perhaps, risks that can be shifted to the government and public).

How high a price is "too high" is in the eye of the beholder. There is a somewhat competitive market between different financial institutions to provide this kind of service, and they cannot just charge whatever they feel like. You may think that 50% of the dividend yield is an absurd price to pay, but someone else may not. It is not a situation where you are paying 1% to an advisor for active management services that are just adding random noise to your returns. You are paying 1% for them to deliver a different return profile, and they do in fact deliver it (unless they go bankrupt and no one bails them out).

You do not need to "outsmart" the bankers. You need to understand what you are getting, what you are paying for it, and whether that price is worth it. Just because something is expensive does not automatically mean that anyone buying it must be foolish. Sophisticated parties sometimes hold structured notes when it makes sense for them to do so (although I have no idea whether they hold structured notes that are similar to this particular Goldman one).
Last edited by HootingSloth on Fri Jun 11, 2021 6:33 pm, edited 1 time in total.
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Re: Are all Structured Notes Bad?

Post by Wrench »

talzara wrote: Fri Jun 11, 2021 3:55 pm
alex_686 wrote: Fri Jun 11, 2021 3:34 pm The market. I am highly confident that Goldman is not on the other side of this note. I am very doubtful that there is a specific party on the other side, even though it sometimes happens. You should be able to replicate the notes using publicly traded options.
There are no publicly-traded 7-year European options. I explained this last year.

Since there are no publicly-traded options, the investment bank can't net it out to "the market" either. If it is netted out, then there has to be a customer. Since there are so many legs to this trade, it may be a combination of customers. One customer may take the S&P 500 and another customer the DJIA, but then Goldman has to act as an options market maker for the worst-of-two risk.
alex_686 wrote: Fri Jun 11, 2021 3:34 pm This is like arguing that index funds are bad because Vanguard takes a cut to manage the fund. The argument does not make any sense. I am sure we could deconstruct the product and estimate Goldman's profit. It probably is on the high side, but certainly not a "rip off".
No, it is like arguing that hedge funds are bad when they charge two-and-twenty. Vanguard charges a lot less.

I already deconstructed the structured note into its underlying derivatives last year. viewtopic.php?p=5324880#p5324880

Goldman is charging double the fair value of the options bundle. If that is not a rip-off, I'd like to know what you actually consider to be a rip-off. Triple? Quadruple? 10 times fair value?
As you have pointed out, it would be possible to recreate this profit profile using options, except for the time frame, and the long term binary options, which are not available to U.S. retail investors (at least as far as I know). One could recreate a somewhat similar profile with LEAPS that are available to retail traders as follows:
Image
i.e.,
1. Long 100 shares SPY stock
2. Short 12 250 Dec 23 Puts
3. Short 1 350 Dec 23 Call
4. Long 1 350 Dec 23 Put
5. Long 2 425 Dec 23 Calls
The difference being the shorter time frame, 2.5 years, and adding additional short 250 puts instead of the binary put. This has the effect of increasing the loss by a factor of ~4x if the price drops below ~250. I would likely close the trade for a loss if SPY got anywhere near 250, at least if it did so within a few months of expiration, or play some other games to reduce the risk. But there is no gain/loss between 250 and today's price at expiration, and one gets 2x the gain if SPY goes up (actually, 2.04 as you can see from the delta). And, the dividends will come to me, not the bank. The trade is roughly gamma neutral, but will be sensitive to vol, with a vega of -701. Just for fun, I put this trade on in a paper account, and if there is interest, I will report back periodically on how it performs.

Wrench
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Re: Are all Structured Notes Bad?

Post by talzara »

alex_686 wrote: Fri Jun 11, 2021 6:07 pm You are wrong. The CME offers these swaptions with tennors up to 30 years since 2016. I will admit that this is a obscure part of the market but there you go.
It's spelled "tenor" with one n.

The CME offers interest rate swaptions.

This Goldman Sachs note is based on worst-of-two options on the the S&P 500 and DJIA indexes. It also includes a worst-of-two binary put. Please post a link to the product page for a 7-year exchange-traded worst-of-two binary put on the S&P 500 and DJIA indexes.
alex_686 wrote: Fri Jun 11, 2021 3:34 pm I am confused. Hedge funds don't charge 2 and 20. And even if they did, so what? They are charging a different price for a different product. And a structured fund is neither a mutual fund nor a hedge fund. Or is your argument that the only valid ice cream in vanilla and that all other flavors are rip offs?
If product prices could only be compared to themselves, then nothing would ever be a rip-off.
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Re: Are all Structured Notes Bad?

Post by talzara »

HootingSloth wrote: Fri Jun 11, 2021 6:18 pm There seems to be some degree of talking past each other here, so I will try to be clear where we agree and where we appear to disagree. ...

How high a price is "too high" is in the eye of the beholder. There is a somewhat competitive market between different financial institutions to provide this kind of service, and they cannot just charge whatever they feel like. You may think that 50% of the dividend yield is an absurd price to pay, but someone else may not. It is not a situation where you are paying 1% to an advisor for active management services that are just adding random noise to your returns. You are paying 1% for them to deliver a different return profile, and they do in fact deliver it (unless they go bankrupt and no one bails them out).
We're certainly looking at it from two different perspectives. You look at Goldman's intentions, and I look only at the results. I give them no credit for good intentions. If it's taking advantage of people's psychological biases, then I don't care if they're doing it deliberately or on accident.

This paragraph is where we disagree head-on. The price is high, but is it always absurd? Can it sometimes be reasonable to some people?

If 50% of the dividend yield isn't absurd, how about 100% of the fair value of the options? Options market makers don't charge a 100% spread on exchange-traded options.

I think 100% is always absurd, and you don't. I think we'll just have to agree to disagree.
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Re: Are all Structured Notes Bad?

Post by HootingSloth »

talzara wrote: Fri Jun 11, 2021 7:35 pm
HootingSloth wrote: Fri Jun 11, 2021 6:18 pm There seems to be some degree of talking past each other here, so I will try to be clear where we agree and where we appear to disagree. ...

How high a price is "too high" is in the eye of the beholder. There is a somewhat competitive market between different financial institutions to provide this kind of service, and they cannot just charge whatever they feel like. You may think that 50% of the dividend yield is an absurd price to pay, but someone else may not. It is not a situation where you are paying 1% to an advisor for active management services that are just adding random noise to your returns. You are paying 1% for them to deliver a different return profile, and they do in fact deliver it (unless they go bankrupt and no one bails them out).
We're certainly looking at it from two different perspectives. You look at Goldman's intentions, and I look only at the results. I give them no credit for good intentions. If it's taking advantage of people's psychological biases, then I don't care if they're doing it deliberately or on accident.

This paragraph is where we disagree head-on. The price is high, but is it always absurd? Can it sometimes be reasonable to some people?

If 50% of the dividend yield isn't absurd, how about 100% of the fair value of the options? Options market makers don't charge a 100% spread on exchange-traded options.

I think 100% is always absurd, and you don't. I think we'll just have to agree to disagree.
Well, I think we agree most of the way on this, so it's OK to disagree a bit as well. It's certainly not worth that much to me. :sharebeer
Global Market Portfolio + modest tilt towards volatility (80/20->60/40 as approach FI) + modest tilt away from exchange rate risk (80% global+20% U.S. stocks; currency-hedge bonds) + tax optimization
Topic Author
orangeinvestor
Posts: 39
Joined: Mon Jun 08, 2020 2:38 pm

Re: Are all Structured Notes Bad?

Post by orangeinvestor »

Wow, I didn't realize that this thread came back to life. I don't think there will ever be a universal consensus but here's a few thoughts form me.
  • I know others will see it differently, I don't think all structured notes are bad. Most are. Almost all are. But not all.
  • Focus on the payoff profile and compare it to the alternatives. I learned from others that notes are put together with some pretty complicated derivatives that are not available to a retail investor. But the payoff profile is actually relatively simple to understand so focus on that. I would suppose most people don't exactly know the inner workings of a car, they still know how to compare, buy and drive them. I looked at at it as a product and compared it to other products that I could actually buy.
  • There should also be an illiquidity premium. For locking up my money for a long time, there should be a significant gain over investing in a liquid investment like an ETF.
  • Make a comparison table looking at the other investments and the note to see at which % gains (or losses) you would be better off investing in the index and where you would be better off investing in the note. And decide if that fits your goals.
Since the crash, I haven't seen any notes that I think are worth it for me these days. Most offer a small buffer or small leverage and I'd rather keep my funds liquid. But if someone offered me another note like the the one I bought last year, I'd seriously consider it again.
BH+
Posts: 109
Joined: Sat Aug 31, 2019 5:15 pm

Re: Are all Structured Notes Bad?

Post by BH+ »

Assuming a principal-protected note (100% protected), the benchmark should be a 5 year bond or CD. Comparison with dividends is misleading, because with stocks, neither the dividend nor the principal is guaranteed. Sure, one could collect 10% of dividends in 5 years, but there is a possibility of a substantial loss on the pricing side.

Looking from an investor's point of view, with a principal-protected note, they are giving up the interest (5 year treasury currently pays 0.74% per year), but gain opportunity to participate, to a degree, in the upside of equity returns. This would depend on the terms of the contract. I could see how this might be reassuring and a good trade off for some nervous investors. To most, it is not relevant how the sausage is made.

The same, by the way, is true for equity investors, i.e. they are giving up the treasury return for a potentially higher return on stocks.
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