According to the Duden dictionary, the word "participation" stands for "taking part, being involved". It can refer to the most diverse areas of life: Society and politics are among them, as are sports and business. The noun, which goes back to the Latin "participatio", has always had a firm place in the market for structured products. Here, participation represents a category of its own. It comprises products that allow investors to participate in the performance of a wide range of underlyings. In addition to individual shares, broadly diversified indices and baskets of shares can be used for this purpose. In the same way, participation products open the door to the asset classes of commodities, bonds or cryptocurrencies even with a small capital investment.
A central component of participation products is the Low Excercise Price Option, also called Zero Strike Call. This is a call option with a strike price close to zero. Since the zero-strike call is therefore quoted deep in the money, it tracks the performance of the underlying instrument almost one-to-one. However, in the case of equities, the investor forgoes accruing dividends - in contrast to direct investment. The distributions are used to finance this structure. In this respect, equities with attractive dividends are particularly interesting as underlyings. By combining the zero strike call with further options, issuers create the different variants of participation products. In addition to the tracker certificate (more on this in the next issue of Leonteq Know-how), outperformance and bonus certificates are among the classic representatives.
The outperformance certificate offers disproportionate participation in the underlying asset. As soon as the underlying asset - usually shares or indices - ends the term above the strike, the outperformance is fixed. If, on the other hand, the underlying asset goes into reverse, the product participates fully in the losses. In this respect, the investor should only go for the outperformance certificate if he expects rising prices for the underlying.
The extent of the possible outperformance depends on the second component of the product. Issuers combine the zero strike call with a call option whose strike corresponds to the current price of the underlying. With an additional at-the-money (ATM) call, the participation doubles to 200%. A half option leads to a participation rate of 150%.
In addition to the expected dividends, volatility plays an important role for the conditions. Reason: The implied price fluctuation range is a central factor in options trading. The lower the volatility of an underlying, the more favorable the purchase of the call option(s) is in principle. Since more options can be purchased in such a constellation, a higher outperformance rate can also be realized.
There are a number of companies listed on the Swiss stock market that carry the title of "dividend stocks". Roche is one of them. At the recent Annual General Meeting of the Basel-based pharmaceutical group, shareholders voted in favor of the 36th consecutive increase in profit sharing. Within the SMI, Roche is also one of the stocks with the lowest volatility. The large cap is therefore predestined as the underlying for an outperformance certificate. Leonteq is taking advantage of this for a new issue. At maturity in three years, the outperformance certificate (Valor: 129028689) participates with 180% in rising Roche prices. If the profit participation certificate remains in the current downtrend, there is no hedge. At maturity, the product would yield a loss corresponding to the negative price trend. The following diagram illustrates how this works.
Starting from the strike, the outperformance certificate stands out from the underlying. Assuming that the Roche non-voting equity security increases in price by 40% over the next three years. The redemption would then amount to 172% of the denomination, so the product would yield a profit of 72%. There is no protection against losses. As soon as Roche ends the term in the red, the balance of the outperformance certificate will also be negative.
At the same time as the product described above, Leonteq has issued an Outperformance Certificate on Roche with Cap (Valor: 129028690). In this variant, the participation is limited upwards. Specifically, the certificate participates in rising prices of the underlying up to the cap level of 130%. In return for this "waiver", a higher participation rate is possible. It amounts to stately 250% with the new issue. In addition to the purchase of the zero strike call and 1.5 calls, the issuer is writing 2.5 call options on Roche, whose strike corresponds to the cap level. The resulting proceeds will be used to finance the structure.
Due to the high participation rate, the payout increases particularly strongly relative to the underlying. Let's assume that the Roche non-voting equity security increases in price by one tenth over the next three years. In this case, the redemption would amount to 125% of the denomination, i.e. the product would yield a profit of one quarter. If the share price rises by 30% or more, the mechanism switches off. The outperformance certificate would then achieve the maximum return of 75%. There is no protection against losses even with this variant.
The construction of outperformance certificates with cap also makes sense for underlyings that pay comparatively low dividends. Due to the cap, a reasonable participation rate is also possible with such shares.
The outlined mode of operation only take effect at expiration. During the term, various factors influence the value of outperformance certificates. In addition to the price of the underlying, these include its implied volatility and the expected dividends. In principle, if the underlying share price rises, the value of the structured product also increases. However, the certificate with cap shows a specific pattern here. The closer the underlying is to the cap, the weaker the product gains in value. If the underlying clearly moves away from the cap, there is hardly any reaction in the certificate with cap.
A discrepancy is also evident in the sensitivity to implied volatility. The outperformance certificate without cap gains in value as soon as the expected price swings go up. For the variant with cap, this only applies in the area of the strike. If the underlying price approaches the maximum amount, the sold (short) call option makes itself felt. Then a rising volatility can even result in a price decline of the certificate at a constant underlying price.
We look forward to answering all of your questions about our products and how they are traded. Please don't hesitate to get in touch! Phone: 058 800 11 11, email info@leonteq.com or contact us here.