Structured products make it possible to navigate in each environment: investors sometimes find better entry points into the market, sometimes a way to hedge their exposure.
Despite geopolitical tensions, economic uncertainties and volatile bond yields, the stock market has seen undeniable momentum this year. Stock indices are reaching new highs, driven in particular by the prospects of productivity gains promised by artificial intelligence (AI) and by better-than-expected corporate results. The performance of developed markets reflects a seemingly insatiable appetite for risk. In addition, the hypothesis of a rate cut (even if postponed) in the West continues to be included in the calculations. The rapid rebound in stocks after the April low seems to indicate that any decline is more of an incentive for investors to return to the market (“buy on dip”) than the start of a real downward sequence. In a word, resisting the temptation of stock market returns in 2024 seems very difficult…
Behind the large capitalizations which “pull the markets”, doubts remain: the American macroeconomy shows cracks; Europe, led by Germany, is showing a moderate recovery and power seems weakened in France. Investors are hesitating between reason, which calls for a more defensive exposure, and the fear of being left out of an unprecedented race for performance.
The race to the market: how to stay invested, but not at any cost
For this second part of 2024, if investors do not want to deprive themselves of the potential for stock market growth, they will have to try to mitigate their risks. This is where structured products and derivative strategies come into play.
There is a solution that combines, on the one hand, the possibility of optimizing cash yield in a neutral to bullish context, and, on the other hand, that of increasing exposure in the event of a market decline.
Beyond the classic structures such as “participation products” which offer exposure to the positive performance of an underlying and conditional protection on the downside, there is a solution which combines, on the one hand, the possibility of optimize the return on cash in a neutral to bullish context, and, on the other hand, that of increasing its exposure in the event of a market decline. This solution called “dropback” or “buy the dip” combines in the same product an attractive coupon (higher than the reference interest rate) on a predefined cash exposure and an initial exposure to a stock market index. The particularity of this solution lies in its automatic reallocation mechanism of cash towards the index. Indeed, if the latter falls below one or more trigger barriers (for example, -5% / -10% / -15%), then the cash is reinvested in the market, at these levels. Thus, the investor maintains exposure to a given index despite a more defensive profile.
Given the strong performance of the American market since the start of the year, it would also have been more costly for many investors to give up investing, rather than financing a modest premium to obtain short-term protection of their exposure. This is the case as long as implied volatility on the markets remains low, which has been the case since the start of the year. In this context, purchasing a Warrant Put for 3 to 6 months which offers protection as soon as the S&P 500 loses more than 5% can prove useful for maintaining a position, while limiting the risk on part of the short-term portfolio. When volatility is low, you can opt for a “lookback max” type variant. Indeed, for a low additional cost, the protection of this same Warrant Put operates from the highest level observed on the market, and this throughout the life of the option. This mechanism also avoids the difficulty of choosing the optimal time for implementing a protection strategy.
The tactical corner: flexibility and diversification
Summer is often associated with lower volumes and more erratic behavior. Thus, tactical adjustments and better diversification may prove wise.
Those who take this view may turn to Reverse Convertibles either as a replacement for an existing position or as a new line in the portfolio. Versions with a purchase price (i.e. strike) more favorable than current prices in the event of conversion remain very effective in optimizing yield while reducing the risk of direct exposure.
Finally, products with capital protection and participation remain the master tools. They combine simplicity and security when interest rates are high and volatility is low. Indeed, by combining the purchase of a zero-coupon bond with that of a Call option, this type of instrument allows you to benefit from the appreciation of an index or a thematic basket, with a known minimum reimbursement (between 90% and 100% of the invested capital). It is also possible to use these solutions on sought-after diversification assets, such as gold or copper. These are therefore effective additional strategies.
