A NEW short-term investment product is available in the Singapore market that offers the opportunity of higher returns while the downside is the same as a share investment.
The idea is simple. The double chance certificate returns twice the profits of the underlying security up to a pre-determined cap strike. For example, let's look at a certificate with a determination price of $100 and cap strike of $115. At issue date, the price of the certificate and the underlying share is the same at $100. In this example, the maximum return at maturity would be $130 (2 x ($115 - $100)). Hence, the return of 30 per cent is achieved with a rise of 15 per cent in the underlying share. If the underlying share is trading lower than the determination price at maturity, then investors will receive one share for every certificate held.
The double chance certificate is an investment product that should be bought with an intention to hold to maturity, at which time the payout of the certificate will be determined solely on the share price, according to the payout formula.
The certificate, during its lifetime, can be traded like a warrant as the market maker will provide two-way quotes in the market. During the life of the certificate, it is important to note that its price may not necessarily move in line with the price of the underlying share.
However, the certificate, during its lifetime, can be traded like a warrant as the market maker will provide two-way quotes in the market. During the life of the certificate, it is important to note that its price may not necessarily move in line with the price of the underlying share. Other factors which may affect the price include remaining time to maturity, volatility, interest rates and dividends.
At maturity, there are four possible scenarios if you compare the certificate with a direct stock investment.
1 Let us assume at maturity, the price of the underlying share is below the determination price ($100). In this case, the investor receives one underlying share (for every double chance certificate). This makes the payout of the certificate equal to the value of the underlying share. In other words: the downside is the same for both investments.
2 Between the determination price and the cap strike ($115) the return of the certificate is always twice the underlying share return, ie, if the underlying share is worth $110 at maturity, the payout will be $120 (2 x ($110 - $100)).
3 The certificate has a maximum return. The return will stay the same (at $130) even if the share is trading above the cap strike of $115. In spite of this cap, the certificate performance will still be better than the underlying shares up to $130. At $130, the underlying share and the certificate will exactly break even.
4 Only at a level above $130 would the underlying share offer a better payoff than the investment in the certificate. However, the share has to gain more than 30 per cent to reach this trigger.
In three of these four scenarios, the investment in the certificate is equal to or better than the underlying share and only in one of the scenarios does the underlying share outperform the certificate. To do this, the share has to gain by more than twice the difference between the determination price and the cap strike (which is 30 per cent in the example).
The structure of this new product offers several strategies.
As a direct investment, investors who expect a moderate rise in the underlying share can use the certificate for the opportunity to double the upside returns (up to the cap strike).
And investors who are holding on to a share bought at a high price and are waiting for the price to go back to that level can switch into the double chance certificate to reach that target much faster since the gains (up to the cap strike) will be doubled.
For investors who are unwilling to take on additional downside risk (compared with share investments), the certificate may be the solution. For a certificate, if the share price is below the determination price at expiry, the investor would simply receive the underlying shares. This means the certificate investor will have exactly the same exposure as the direct share investment.
The writer is vice-president, investment products group warrants, Deutsche Bank.
