Riding the tiger of volatility
Equity-linked products with low principal risk face a problem when interest rates are low. There's too little discount on a zero-coupon bond, especially a short-dated one, to give the investor much upside on stocks using options. One investment banker says: "The solution is to look for exotic options to provide geared exposure."
Since 1997, barrier options have become almost plain vanilla. A knock-out call, for example, is cancelled once the underlying stock hits a trigger level. A knock-in gives you no upside until the stock hits a trigger. Other common exotics are digitals, which give a one-off payout at a trigger and that's it. Cliquets are option strips: each option expires and another kicks in with a strike linked to the spot.
SG's creations include corridor notes, which pay you a high coupon as long as a stock trades within a specified path. Constructing this involves daily barrier options.
Extendables are reverse convertibles with embedded knock-outs and step-down coupons. You buy a high-coupon bond and sell an index put. If the index rises to a trigger, the put knocks out and the bond is repayed early at par.