Equity-linked Notes (ELN)

[camelking]

I have nothing else to add except that I concur with almost everyone's statement here.

Don't touch even if you think you know or your banker tells you that its absolutely safe.
Nothing is safe, not even Fixed deposits if the bank collapsed and government refuse to honour its guarantee.

This ELN is an option. There is always a counterparty opposite whenever you buy instrument.
How would you know that the counterparty has no prior knowledge that their bet is correct? You could be betting against the investment banks, fund managers who have more resources and connections than yourself.
Could you tell yourself you know better than the counterparty? Unless you can confidently tell yourself this, otherwise hands off.

I strongly discourage leverage on these financial instruments as a wrong step will bring untold misery onto not only onself but the loved ones around us.

But if i can find , let's say for example SPH as ELN and its strike price is what i may buy in the market, can you tell me where the danger lies? Is it the third party may not honour the contract or more other dangers? But so far don't think i can find an agreeable strike price besides the interest rate may not be that attractive too. Assuming no leverage is used, what are the dangers or risks?

If you are more than willing to buy the underlying stocks at strike price (Note: the actual price of the underlying stock could be much lower than strike price at final valuation date), the other risk is COUNTER PARTY RISK!
In the event, the counter party collapses, you may not get the underlying stock and your initial investment back.
haha!

[AlphaQuant]

If you are more than willing to buy the underlying stocks at strike price (Note: the actual price of the underlying stock could be much lower than strike price at final valuation date), the other risk is COUNTER PARTY RISK!
In the event, the counter party collapses, you may not get the underlying stock and your initial investment back.
haha!

that's not true. the bank which has sold the product has the RIGHT to sell the investor the underlying (if it is physically delivered) at a HIGHER price than the prevailing market, if the stock has collapsed.

[weijian]

I have nothing else to add except that I concur with almost everyone's statement here.

Don't touch even if you think you know or your banker tells you that its absolutely safe.
Nothing is safe, not even Fixed deposits if the bank collapsed and government refuse to honour its guarantee.

This ELN is an option. There is always a counterparty opposite whenever you buy instrument.
How would you know that the counterparty has no prior knowledge that their bet is correct? You could be betting against the investment banks, fund managers who have more resources and connections than yourself.
Could you tell yourself you know better than the counterparty? Unless you can confidently tell yourself this, otherwise hands off.

I strongly discourage leverage on these financial instruments as a wrong step will bring untold misery onto not only onself but the loved ones around us.

But if i can find , let's say for example SPH as ELN and its strike price is what i may buy in the market, can you tell me where the danger lies? Is it the third party may not honour the contract or more other dangers? But so far don't think i can find an agreeable strike price besides the interest rate may not be that attractive too. Assuming no leverage is used, what are the dangers or risks?

I saw parallels in the Lehman's minibond saga. To a layman, in both instances, buyers of minibonds and ELN are essentially selling insurance to people who want to hedge against their portfolio. In good times, insurers want to enjoy these premiums. As they get addicted and complacent, they will start to compete and offer lower premiums and eventually lock down future losses. As the saying goes 'What the wise man does in the beginning, the fool does'. Personally, i rather be buying insurance to hedge against that black swan event, rather than the other side of the deal.

On another hand, counterparty risk may not be restricted to the 3rd party equity holder who bought your insurance. What about the bank itself as been the broker? (if it wasnt betting against u). We all know that minibonds=0 value when the Lehman self destructed.

---

I vividly remember Warren Buffett's view on cash - it is a call option with YOUR determined strike price and has NO expiry date. Of course, the premium paid for this call option, is the opportunity costs lost in chasing capital gains/yields.

As a non-financially trained fella (ie. an engineer), i try to simplify things and hence i would view an ELN (selling put options) and cash ( buying a call option) as very similar in nature in my portfolio. The differences is that an ELN's terms/conditions are NOT set by me, while cash's terms/conditions ARE set by me.

[Temperament]

If you are more than willing to buy the underlying stocks at strike price (Note: the actual price of the underlying stock could be much lower than strike price at final valuation date), the other risk is COUNTER PARTY RISK!
In the event, the counter party collapses, you may not get the underlying stock and your initial investment back.
haha!

that's not true. the bank which has sold the product has the RIGHT to sell the investor the underlying (if it is physically delivered) at a HIGHER price than the prevailing market, if the stock has collapsed.

So we have different understandings of the ELN. Ah!

What i understand from banking RM is i will take delivery of the stock at the agreed strike price (within the contract period) even if the market tanked or the stock tanked. This is O. K. as i enjoy higher interest rate if the contract lapse without hitting the strike price.
Another words i become an insurance company.
i think the most important thing is to scrutinize the actual contract very carefully.
Is ELN's contract standard set by our "beloved MAS" or the banks can set or vary their terms of contract? i suppose the latter is true as long as the banks don't breach any MAS's regulations or terms of contract regulations.
i suppose within the contract period, the counter party can trade like mad with the stock as i have become the insurance party.

[AlphaQuant]

Is ELN's contract standard set by our "beloved MAS" or the banks can set or vary their terms of contract? i suppose the latter is true as long as the banks don't breach any MAS's regulations or terms of contract regulations.
i suppose within the contract period, the counter party can trade like mad with the stock as i have become the insurance party.

ELNs are sold OTC (i.e. over the counter) - noone is responsible other than the investor. The fact that the investor will already be an "accredited investor" in black-and-white washes the bank of any mis-selling liability. So in a way, it is better to pretend to be as stupid as possible and not sign any documents proving you are capable.

you are very right on the "trade-like-mad" part - in fact that is how the hedger makes money on the realised vs implied vol spread - the bank has bought convexity through the options and will then gamma scalp as hard as possible throughout the tenor of the contract.

[Temperament]

Is ELN's contract standard set by our "beloved MAS" or the banks can set or vary their terms of contract? i suppose the latter is true as long as the banks don't breach any MAS's regulations or terms of contract regulations.
i suppose within the contract period, the counter party can trade like mad with the stock as i have become the insurance party.

ELNs are sold OTC (i.e. over the counter) - noone is responsible other than the investor. The fact that the investor will already be an "accredited investor" in black-and-white washes the bank of any mis-selling liability. So in a way, it is better to pretend to be as stupid as possible and not sign any documents proving you are capable.

you are very right on the "trade-like-mad" part - in fact that is how the hedger makes money on the realised vs implied vol spread - the bank has bought convexity through the options and will then gamma scalp as hard as possible throughout the tenor of the contract.

Ah i see! The bank will make me sign a document that say i am a "Professor of Stock Investment". But if i don't want to sign, i don't think the bank will sell me the ELN contract. Ha! Ha! i see! Its all my fault and none of theirs.

---

I have nothing else to add except that I concur with almost everyone's statement here.

Don't touch even if you think you know or your banker tells you that its absolutely safe.
Nothing is safe, not even Fixed deposits if the bank collapsed and government refuse to honour its guarantee.

This ELN is an option. There is always a counterparty opposite whenever you buy instrument.
How would you know that the counterparty has no prior knowledge that their bet is correct? You could be betting against the investment banks, fund managers who have more resources and connections than yourself.
Could you tell yourself you know better than the counterparty? Unless you can confidently tell yourself this, otherwise hands off.

I strongly discourage leverage on these financial instruments as a wrong step will bring untold misery onto not only onself but the loved ones around us.

But if i can find , let's say for example SPH as ELN and its strike price is what i may buy in the market, can you tell me where the danger lies? Is it the third party may not honour the contract or more other dangers? But so far don't think i can find an agreeable strike price besides the interest rate may not be that attractive too. Assuming no leverage is used, what are the dangers or risks?

I saw parallels in the Lehman's minibond saga. To a layman, in both instances, buyers of minibonds and ELN are essentially selling insurance to people who want to hedge against their portfolio. In good times, insurers want to enjoy these premiums. As they get addicted and complacent, they will start to compete and offer lower premiums and eventually lock down future losses. As the saying goes 'What the wise man does in the beginning, the fool does'. Personally, i rather be buying insurance to hedge against that black swan event, rather than the other side of the deal.

On another hand, counterparty risk may not be restricted to the 3rd party equity holder who bought your insurance. What about the bank itself as been the broker? (if it wasnt betting against u). We all know that minibonds=0 value when the Lehman self destructed.

---

I vividly remember Warren Buffett's view on cash - it is a call option with YOUR determined strike price and has NO expiry date. Of course, the premium paid for this call option, is the opportunity costs lost in chasing capital gains/yields.

As a non-financially trained fella (ie. an engineer), i try to simplify things and hence i would view an ELN (selling put options) and cash ( buying a call option) as very similar in nature in my portfolio. The differences is that an ELN's terms/conditions are NOT set by me, while cash's terms/conditions ARE set by me.

Well put. This is another way to look at ELN.

[revolta]

I think as long as i do not take leverage, it should be safe.
Buying the current stock at current price will be more risky for me, i rather earn some interest and hold the stock if the price fall to my strike price.

[camelking]

If you are more than willing to buy the underlying stocks at strike price (Note: the actual price of the underlying stock could be much lower than strike price at final valuation date), the other risk is COUNTER PARTY RISK!
In the event, the counter party collapses, you may not get the underlying stock and your initial investment back.
haha!

that's not true. the bank which has sold the product has the RIGHT to sell the investor the underlying (if it is physically delivered) at a HIGHER price than the prevailing market, if the stock has collapsed.

So we have different understandings of the ELN. Ah!

What i understand from banking RM is i will take delivery of the stock at the agreed strike price (within the contract period) even if the market tanked or the stock tanked. This is O. K. as i enjoy higher interest rate if the contract lapse without hitting the strike price.
Another words i become an insurance company.
i think the most important thing is to scrutinize the actual contract very carefully.
Is ELN's contract standard set by our "beloved MAS" or the banks can set or vary their terms of contract? i suppose the latter is true as long as the banks don't breach any MAS's regulations or terms of contract regulations.
i suppose within the contract period, the counter party can trade like mad with the stock as i have become the insurance party.

yes, my understanding is same as yours....But as mentioned earlier, beware of counter party risk....

You are essentially selling a put option on the underlying stocks, so, yes, you are writing insurance.

My company made so much from buying ELNs last year...

---

I think as long as i do not take leverage, it should be safe.
Buying the current stock at current price will be more risky for me, i rather earn some interest and hold the stock if the price fall to my strike price.

You are right as long as you are prepared to lose the entire investment.
Enjoy the trip....

[revolta]

I am curious how bank or issuing company of ELN earn money?

once i bought ELN, it will have 3 scenario:
1) stock price move up and i get the interest.
2) stock price remain same value and i get the interest.
3) stock price goes down and hit my strike price, i carry the stock.

Does bank or issuing company earn from all 3 scenario?

[AlphaQuant]

I am curious how bank or issuing company of ELN earn money?

once i bought ELN, it will have 3 scenario:
1) stock price move up and i get the interest.
2) stock price remain same value and i get the interest.
3) stock price goes down and hit my strike price, i carry the stock.

Does bank or issuing company earn from all 3 scenario?

an ELN typically involves the purchase of a bond and an option.

the issuer makes off the spread all the time i.e. it purchases the bond+option at a lower price, packages it into a note, and then sells the paper to the investor at a higher price.

the spread is locked in and does not depend on whether the investor makes or loses - what matters is to sell them to as many people as possible to make as much of the spread as possible.